EarthLink Holdings Corp.
EARTHLINK INC (Form: 10-K, Received: 02/26/2010 15:57:51)

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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-K


ý

 

ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended December 31, 2009

OR

o

 

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

For the transition period from to

Commission File Number: 001-15605

EARTHLINK, INC.
(Exact name of registrant as specified in its charter)

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

1375 Peachtree St., Atlanta, Georgia 30309
(Address of principal executive offices, including zip code)

(404) 815-0770
(Registrant's telephone number, including area code)

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

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



        Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes  ý     No  o

        Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes  o     No  ý

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

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

        Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation of S-K is not contained herein, and will not be contained, to the best of the registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  o

        Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See definition of "large accelerated filer," "accelerated filer" and "smaller reporting company" in Rule 12b-2 of the of the Exchange Act (Check One):

Large accelerated filer  ý   Accelerated filer  o   Non-accelerated filer  o
(Do not check if a smaller reporting company)
  Smaller Reporting Company  o

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

        The aggregate market value of the registrant's outstanding common stock held by non-affiliates of the registrant on June 30, 2009 was $784.6 million. As of January 29, 2010, 107,283,136 shares of common stock were outstanding.

        Portions of the Proxy Statement to be filed with the Securities and Exchange Commission and to be used in connection with the Annual Meeting of Stockholders to be held on May 4, 2010 are incorporated by reference in Part III of this Form 10-K.


Table of Contents


EARTHLINK, INC.
Annual Report on Form 10-K
For the Year Ended December 31, 2009

TABLE OF CONTENTS

PART I

 

Item 1.

 

Business

   
1
 

Item 1A.

 

Risk Factors

   
11
 

Item 1B.

 

Unresolved Staff Comments

   
23
 

Item 2.

 

Properties

   
23
 

Item 3.

 

Legal Proceedings

   
23
 

Item 4.

 

Submission of Matters to a Vote of Security Holders

   
23
 

PART II

 

Item 5.

 

Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

   
24
 

Item 6.

 

Selected Financial Data

   
26
 

Item 7.

 

Management's Discussion and Analysis of Financial Condition and Results of Operation

   
28
 

Item 7A.

 

Quantitative and Qualitative Disclosures about Market Risk

   
59
 

Item 8.

 

Financial Statements and Supplementary Data

   
61
 

Item 9.

 

Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

   
107
 

Item 9A.

 

Controls and Procedures

   
107
 

Item 9B.

 

Other Information

   
107
 

PART III

 

Item 10.

 

Directors, Executive Officers and Corporate Governance

   
108
 

Item 11.

 

Executive Compensation

   
108
 

Item 12.

 

Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

   
108
 

Item 13.

 

Certain Relationships and Related Transactions, and Director Independence

   
109
 

Item 14.

 

Principal Accounting Fees and Services

   
109
 

PART IV

 

Item 15.

 

Exhibits, Financial Statement Schedules

   
110
 

SIGNATURES

   
114
 

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FORWARD-LOOKING STATEMENTS

        Certain statements in this Annual Report on Form 10-K are forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995, Section 27A of the Securities Act of 1933, and Section 21E of the Securities Exchange Act of 1934. The words "estimate," "plan," "intend," "expect," "anticipate," "believe" and similar expressions are intended to identify forward-looking statements. These forward-looking statements are found at various places throughout this report. EarthLink, Inc. disclaims any intention or obligation to update or revise any forward-looking statements, whether as a result of new information, future events or otherwise. Although EarthLink, Inc. believes that its expectations are based on reasonable assumptions, it can give no assurance that its targets and goals will be achieved. Important factors that could cause actual results to differ from estimates or projections contained in the forward-looking statements are described under "Risk Factors" in Item 1A of Part I and under "Safe Harbor Statement" in Item 7 of Part II.


PART I

Item 1.    Business.

Overview

        EarthLink, Inc. is an Internet service provider ("ISP"), providing nationwide Internet access and related value-added services to individual and business customers. Our primary service offerings are dial-up and high-speed Internet access services and related value-added services, such as ancillary services sold as add-on features to our Internet access services, search and advertising. In addition, through our wholly-owned subsidiary, New Edge Networks ("New Edge"), we build and manage IP-based wide area networks for businesses and communications carriers.

        We operate two reportable segments, Consumer Services and Business Services. Our Consumer Services segment provides Internet access and related value-added services to individual customers. These services include dial-up and high-speed Internet access and voice-over-Internet Protocol ("VoIP") services, among others. Our Business Services segment provides integrated communications services and related value-added services to businesses and communications carriers. These services include managed IP-based wide area networks, dedicated Internet access and web hosting, among others. See Note 18, "Segment Information," of the Notes to Consolidated Financial Statements in Item 8 of Part II for additional information.

        We were formed in February 2000 as a result of the merger of EarthLink Network, Inc. and MindSpring Enterprises, Inc. We were incorporated in 1999 and are a Delaware corporation. Our corporate offices are located at 1375 Peachtree St., Atlanta, Georgia 30309, and our telephone number at that location is (404) 815-0770.

Business Strategy

        Our business strategy is to maximize the cash flows generated by our business by focusing on customer retention, operational efficiency and opportunities for growth.

    Customer Retention.   We are focused on retaining our customers. We believe focusing on the customer relationship increases loyalty and reduces churn. We also believe that satisfied customers provide cost benefits, including reduced call center support costs and reduced bad debt expense. We continue to focus on offering our access services with high-quality customer service and technical support.

    Operational Efficiency.   We are focused on improving the cost structure of our business and aligning our cost structure with trends in our revenue, without impacting the quality of services we provide. We are focused on delivering our services more cost effectively by reducing and more efficiently

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      handling the number of calls to contact centers, managing cost-effective outsourcing opportunities, managing our network costs, implementing workforce reduction initiatives and streamlining our internal processes and operations.

    Opportunities for Growth.   In response to changes in our business, we have significantly reduced our sales and marketing spending during the past two years. However, we continue to seek to add customers that generate an acceptable rate of return and increase the number of subscribers we add through alliances, partnerships and acquisitions from other ISPs. We continue to evaluate and consider potential strategic transactions that may complement our business. We are also seeking ways to create more scale within our New Edge business.

        The primary challenges we face in executing our business strategy are managing the rate of decline in our revenues, aligning costs with trends in our revenue, responding to competition, reducing churn, purchasing cost-effective network services from third-party telecommunications service providers and adding customers that generate an acceptable rate of return. The factors we believe are instrumental to the achievement of our business strategy may be subject to competitive, regulatory and other events and circumstances that are beyond our control. Further, we can provide no assurance that we will be successful in achieving any or all of the strategies identified above, that the achievement or existence of such strategies will favorably impact profitability, or that other factors will not arise that would adversely affect future profitability.

Consumer Services Segment

Service Offerings

Narrowband Access

        Premium Dial-up Internet Access.     Our premium dial-up, or narrowband, access is a subscription-based service that provides customers with access to the Internet and a wide variety of content, features, services, applications, tools and 24/7 customer support. Such features include antivirus and firewall protection, acceleration tools and privacy and safety tools. Revenues primarily consist of fees charged to customers for dial-up Internet access.

        Value Dial-up Internet Access.     We provide value-priced dial-up access services through our PeoplePC TM Online offering. Our value dial-up access is a subscription-based service that provides customers access to the Internet at comparatively lower prices. We also provide to our value-priced dial-up access customers accelerator technology that speeds up customers' page load times by compressing and simplifying web pages. Revenues primarily consist of fees charged to customers for dial-up Internet access.

Broadband Access

        High-speed, or broadband, access offers a high speed, always on Internet connection that uses a modem to supply an Internet connection across an existing home phone line or cable connection. The Internet service doesn't interfere with a customer's voice service, so there is no need for a second phone line. We provide high-speed access services via DSL and cable and offer different speeds of service. Availability for these services depends on the telephone or cable service provider. Our high-speed access service includes the same features and benefits included with our premium dial-up access service, including antivirus and firewall protection, privacy and safety tools and 24/7 customer support. Broadband access revenues primarily consist of fees charged for high-speed access services.

VoIP

        We provide two VoIP services. EarthLink DSL and Home Phone Service is a bundle offer that includes EarthLink high-speed Internet access and home phone service. It combines the last mile of traditional telephone copper wiring with the advanced features of VoIP by taking advantage of Digital

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Subscriber Line Access Multiplexer, or DSLAM, technology. We offer subscription-based service under various plans that include features such as voicemail, call waiting, caller ID, call forwarding and E911 service. We currently offer this service in 12 markets in the U.S. Revenues primarily consist of fees charged to customers for VoIP service plans.

        We also provide Internet-based phone service that enables our customers to make and receive phone calls with a telephone in any location where our broadband Internet access is available. We transmit these calls using VoIP technology, which converts voice signals into digital data packets for transmission over the Internet. We offer subscription-based service under various plans that include features such as voicemail, call waiting, caller ID, call forwarding and E911 service. Revenues primarily consist of fees charged to customers for VoIP service plans.

Value-Added Services

        We offer services which are incremental to our Internet access services. Our value-added services portfolio includes products for protection, communication and performance, such as security products, premium email only, home networking, email storage and Internet call waiting, among others. We offer free and fee-based value-added services to both subscribers and non-subscribers.

        We also generate advertising revenues by leveraging the value of our customer base and user traffic; through paid placements for searches, powered by the Google TM search engine; fees generated through revenue sharing arrangements with online partners whose products and services can be accessed through our web properties; commissions received from partners for the sale of partners' services to our subscribers; and sales of advertising on our various web properties.

Sales and Distribution

        In response to changes in our business and industry, we have significantly reduced our sales and marketing spending during the past two years. Our marketing efforts are currently focused on retaining customers and adding customers through alliances, partnerships and acquisitions from other ISPs that generate an acceptable rate of return. We offer our products and services primarily through direct customer contact through our call centers, search engine marketing, affinity marketing partners such as AARP and Dell, resellers and marketing alliances such as Time Warner Cable.

Customer Service and Retention

        We believe that quality customer service and technical support increase customer satisfaction, which reduces churn. We also believe that satisfied customers provide cost benefits, including reduced call center support costs and reduced bad debt expense. We provide high-quality customer service, invest in loyalty and retention efforts and continually monitor customer satisfaction for our services. Our customer support is available by chat, email and phone as well as through help sites and Internet guide files on our web sites. We have been recognized historically by customer service and marketing organizations for ranking high in customer satisfaction for our dial-up and high-speed Internet services.

        In addition to our customer support, our free tools offer protection against email viruses, spyware, spam, pop-ups and online scams, as well as dial-up Web acceleration. We believe that providing these tools also increases customer satisfaction, which reduces churn.

Network Infrastructure

        We provide subscribers with Internet access primarily through third-party telecommunications service providers. Our principal provider for narrowband services is Level 3 Communications, Inc. ("Level 3"). Our agreement with Level 3 expires in December 2010. We also have agreements with certain regional and local narrowband providers. We have agreements with AT&T Inc. ("AT&T"), Covad Communications

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Group, Inc. ("Covad"), Qwest Corporation ("Qwest") and Verizon Communications Inc. ("Verizon") that allow us to provide DSL services. We have agreements with Time Warner Cable that allow us to provide broadband services over Time Warner Cable's and Bright House Networks' cable network in substantially all their markets and with Comcast Corporation ("Comcast") that allow us to provide broadband services over Comcast's cable network in certain Comcast markets. We rely on Covad's line-powered voice access to provide our EarthLink DSL and Home Phone Service. The following summarizes the contract expiration dates for our largest providers of broadband access:

Broadband Network Provider
  Contract Expiration

Comcast Corporation

  December 2010

Verizon Communications Inc. 

  March 2011

Covad Communications Group, Inc. 

  April 2011

AT&T Inc. 

  May 2011

Time Warner Cable/Bright House Networks

  November 2011

Qwest Corporation

  November 2012

        We maintain a leased backbone consisting of a networked loop of connections between multiple cities and our technology centers. We maintain data centers in multiple locations with redundant systems to provide service availability and connectivity.

Competition

        Access and service.     We operate in the Internet access services market, which is extremely competitive. We compete directly or indirectly with established online services companies, such as AOL and the Microsoft Network; national communications companies and local exchange carriers, such as AT&T, Qwest and Verizon; cable companies providing broadband access, including Charter Communications, Inc., Comcast, Cox Communications, Inc. and Time Warner Cable; local and regional ISPs; free or value-priced ISPs, such as United Online, Inc. which provides services under the brands Juno and NetZero; wireless Internet service providers; content companies, such as Google and Yahoo!; and satellite and fixed wireless service providers. Competitors for our VoIP services include established telecommunications and cable companies; ISPs; leading Internet companies; and companies that offer VoIP services as their primary business, such as Vonage. Current and prospective competitors for our access services include many large companies that have substantially greater market presence and greater financial, technical, marketing and other resources than we have. Competition in the market for access services is likely to continue increasing, and competition could cause us to decrease the pricing of our services, increase churn of our existing customers, increase operating costs or decrease the number of subscribers we are able to add.

        We experience pricing pressures for certain of our consumer access services, particularly our consumer broadband services, due to competition, volume-based pricing and other factors. Some providers have reduced and may continue to reduce the retail price of their Internet access services to maintain or increase their market share, which could cause us to reduce, or prevent us from raising, our prices. We may encounter further market pressures to: migrate existing customers to lower-priced service offerings; restructure service offerings to offer more value; reduce prices; and respond to particular short-term, market-specific situations, such as special introductory pricing or new product or service offerings. Any of the above could adversely affect our revenues and profitability.

        We believe the primary competitive factors in the Internet access service industry are price, speed, features, coverage area and quality of service. While we believe our Internet access services compete favorably based on some of these factors when compared to some Internet access providers, we are at a competitive disadvantage relative to some or all of these factors with respect to some of our competitors. Our dial-up Internet access services do not compete favorably with broadband services with respect to speed, and dial-up Internet access services no longer have a significant, if any, price advantage over certain

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broadband services. Most of the largest providers of broadband services, such as cable and telecommunications companies, control their own networks and offer a wider variety of services than we offer, including voice, data and video services. Their ability to bundle services and to offer broadband services at prices below the price that we can profitably offer comparable services puts us at a competitive disadvantage.

        Value-added services.     The companies we compete with for Internet access services also compete with us for subscribers to value-added services, such as email storage and security products. We compete for advertising revenues with major ISPs, content providers, large web publishers, web search engine and portal companies, Internet advertising providers, content aggregation companies, social-networking web sites, and various other companies that facilitate Internet advertising. Competition in the market for value-added services may impact the rates we charge.

Business Services Segment

Service Offerings

Secure IP-Based Networks

        Through New Edge, we provide IP-based networks for business customers. Customers can choose a blend of access technologies including DSL, T1 and DS3 lines, Ethernet and wireless broadband. We use Multi-Protocol Label Switching ("MPLS") technology, which enables businesses to combine a variety of applications of their choice on a single network to optimize bandwidth and provide reliable network performance. MPLS also enables class of service ("CoS") tagging of network traffic, so administrators may prioritize which of their applications should move across the network ahead of others. Customer applications run on our mix of internal and public Internet links. Revenues consist of fees charged for managed IP-based networks, installation fees, termination fees, fees for equipment and cost recovery fees billed to customers.

        Through New Edge, we also provide virtual private networks ("VPN") and CPE-based VPNs. VPNs are secure networks that link multiple customer locations using Internet-based transmission capacity. Our VPN solutions also provide businesses with a cost-effective means of creating their own secure networks for their traveling workforce, telecommuters and remote offices. Revenues consist of fees charged for access technologies, installation fees, termination fees, fees for equipment and cost recovery fees billed to customers.

Internet Access

        We provide high-speed and dial-up Internet access for business customers. We offer various speeds, reliable connectivity, business-class features like static IP addresses, multiple email accounts and customer service that is available 24/7. Revenues primarily consist of fees charged for Internet access, installation fees and usage fees.

Wholesale Services

        Through New Edge, we provide network services to communications carriers, which bundle New Edge services with their own to provide solutions to the end customer. Revenues consist of fees charged for network services, termination fees, fees for equipment and usage fees.

Web Hosting

        We lease server space and provide web hosting services that enable customers to build and maintain an effective online presence. Features include domain names, storage, mailboxes, software tools to build websites, e-commerce applications and 24/7 customer support. Revenues primarily consist of fees charged to customers for web hosting packages and domain registration fees.

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Other Services

        We offer a variety of other services that eliminate the inconvenience and complexity of managing multiple carrier relationships, technologies and geographic locations. These services enable our business customers to focus on their core business while we manage the network infrastructure. We believe our customers benefit from one seamless network, one provider and one point of contact for their total connection needs. These services include installation programs, managed network services, remote access and disaster recovery, among others.

Sales and Distribution

        We sell our services to end user business customers and to wholesale customers. Our end users range from large enterprises with many locations, to small and medium-sized multi-site businesses to business customers with one site, often a home-based location. Our wholesale customers consist primarily of telecommunications carriers and network resellers. The mix of our business services customer base has shifted towards end users as a result of consolidation in the telecommunications industry. We sell services through direct channels, which include our direct sales force, telephone and web sales groups. We also sell our services indirectly via a variety of third parties such as sales agents and referral partners.

Network Infrastructure

        New Edge's network is comprised of a mix of ATM and IP switches in locations across the U.S. In addition, New Edge has access under wholesale agreements to extend its footprint where it does not have a physical presence. New Edge has interconnection agreements with all major local exchange carriers to lease unbundled network elements, as well as commercial services agreements with national communications companies, competitive local exchange carriers ("CLECs"), and cable and wireless service providers to provide last mile access to its customers and connectivity onto its network.

Competition

        We face significant competition in our business segment markets and we expect this competition to intensify. These markets are rapidly changing due to industry consolidation, an evolving regulatory environment and the emergence of new technologies. We compete directly or indirectly with incumbent local exchange carriers ("ILECs"), such as AT&T, Qwest and Verizon; other competitive telecommunications companies, such as Covad, Level 3, Megapath and XO Holdings; interexchange carriers, such as Sprint Nextel; wireless and satellite service providers; and cable service providers, such as Charter Communications, Inc., Comcast, Cox Communications, Inc. and Time Warner Cable. We believe the primary competitive factors in our business markets include price, availability, reliability of service, network security, variety of service offerings, quality of service and reputation of the service provider. While we believe our business services compete favorably based on some of these factors, we are at a competitive disadvantage relative to some or all of these factors with respect to some of our competitors. The market for telecommunications services, particularly local exchange services, remains dominated by the ILECs, each of which owns the majority of the local exchange network in its respective operating region of the U.S. Each ILEC has significantly more resources available to expand its penetration within the operating regions where we compete. In addition, industry consolidation has resulted in larger competitors that have greater economies of scale. Additionally, new competitors such as VoIP providers and cable companies have entered the market to compete with traditional, facilities-based telecommunications services providers. The operating results of our Business Services segment may be adversely affected by increased subscriber acquisition and retention costs necessary to attract and retain subscribers in a difficult economic environment.

        We also provide web hosting services that enable customers to build and maintain an effective online presence. The web hosting market is highly fragmented, has low barriers to entry and is characterized by

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considerable competition on price and features. We compete directly or indirectly with a number of companies, such as GoDaddy.com, Rackspace Hosting, Inc., Web.com and Yahoo!. Some of these companies have substantially greater market presence and greater financial, technical, marketing and other resources than we have. Competition could cause us to decrease the pricing of our services, increase churn of our existing customers, increase operating costs or decrease the number of subscribers we are able to add.

Regulatory Environment

Overview

        The regulatory environment relating to our business continues to evolve. A number of legislative and regulatory proposals under consideration by federal, state and local governmental entities may lead to the repeal, modification or introduction of laws or regulations which do, or could, affect our business.

Internet Access Regulation

Narrowband Internet Access

        The regulatory environment for narrowband Internet access services is well established. Beginning in the 1970s, the Federal Communication Commission's ("FCC's") policy has been to classify narrowband Internet access services as "information services", which are not subject to traditional telecommunications services regulation, such as licensing or pricing regulation. Under this framework, ISPs are assured access to the narrowband telecommunications transmission service of telephone carriers needed to provide narrowband Internet access information services. Any change to these rules that would apply per-minute carrier access charges to dial-up Internet access traffic could significantly impact our costs for this service.

        One potential risk to our dial-up business would be a change to the rules governing how charges for ISP-bound traffic on telecommunications networks are levied. While Internet traffic is not subject to the FCC's carrier access charge regime, dial-up ISP bound traffic is regulated by the FCC. The FCC has established a uniform, nationwide rate for ISP-bound traffic, but these rules have been criticized by the courts and further judicial scrutiny is expected. Changes to the rules governing dial-up ISP bound traffic could impact our cost of providing this service.

Broadband Internet Access

        The FCC classifies broadband Internet access as a single, commingled information service, whether provided over DSL by telephone companies or over cable modem by cable companies. As a result, cable companies and telephone companies that offer a broadband Internet access information service are not required by the FCC to offer unaffiliated ISPs stand-alone broadband transmission. We have entered into several commercial agreements with cable and telephone companies to offer broadband access to our customers. However, if our contracts with cable companies and telephone companies were to expire and not be replaced, our broadband Internet access customer base and revenues would be adversely affected.

Forbearance

        The Communications Act of 1934, as amended, provides the FCC with the authority to not enforce, or "forbear" from enforcing, statutory requirements and regulations if certain public interest factors are satisfied. If the FCC were to forbear from enforcing regulations that have been established to enable competing broadband Internet access and VoIP, our business could be adversely affected.

        In December 2007, the FCC denied a petition by Verizon that requested the FCC forbear from certain telephone facilities leasing rules in six major east coast markets, including New York and Philadelphia. In July 2008, the FCC denied a similar forbearance petition filed by Qwest seeking regulatory relief in four major west coast markets, including Seattle and Phoenix. We opposed both the Verizon and Qwest

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forbearance petitions by arguing that such deregulation would have removed critical facilities necessary to provide competitive broadband access to consumer and business customers. Both Verizon and Qwest have appealed the FCC orders denying their respective requests.

        We expect reform to the FCC's forbearance review process in the near future. The FCC has initiated a proceeding to establish strict evidentiary and filing procedures for review of forbearance petitions.

Internet Taxation

        The Internet Tax Non-Discrimination Act, which is in effect through November 2014, places a moratorium on taxes on Internet access and multiple, discriminatory taxes on electronic commerce. Certain states have enacted various taxes on Internet access and electronic commerce, and selected states' taxes are being contested on a variety of bases. If these state tax laws are not successfully contested, or if future state and federal laws imposing taxes or other regulations on Internet access and electronic commerce are adopted, our cost of providing Internet access services could be increased and our business could be adversely affected.

Consumer Protection

        Federal and state governments have adopted consumer protection laws and undertaken enforcement actions to address advertising and user privacy. As part of these efforts, the Federal Trade Commission ("FTC") and some state Attorney General offices have conducted investigations into the privacy practices of companies that collect information about individuals on the Internet. The FTC and various state agencies as well as individuals have investigated and asserted claims against, or instituted inquiries into, ISPs in connection with marketing, billing, customer retention, cancellation and disclosure practices.

Universal Service

        While current policy exempts broadband access services from the Universal Service Fund ("USF"), the Congress and FCC may consider expanding the USF to include broadband Internet access services. This change could allow broadband service providers to receive a subsidy for deploying broadband in rural and underserved areas, but it will most likely require broadband service providers to contribute to the USF as well. If broadband Internet access providers become subject to USF contribution obligations, they would likely impose a USF surcharge on end users. Such a surcharge will raise the effective cost of our broadband services to our customers, and could affect customer satisfaction or our revenues and profitability.

Other Laws and Regulations

        Our business also is subject to a variety of other U.S. laws and regulations that could subject us to liabilities, claims or other remedies, such as laws relating to bulk email or "spam," access to various types of content by minors, anti-spyware initiatives, encryption, data protection, data retention and security breaches. Compliance with these laws and regulations is complex and may require significant costs. In addition, the regulatory framework relating to Internet services is evolving and both the federal government and states from time to time pass legislation that impacts our business. It is likely that additional laws and regulations will be adopted that would affect our business.

CLEC Regulation

        New Edge is a competitive local exchange carrier ("CLEC") that is licensed in most states and subject to both state and federal telecommunications regulation. CLECs, like New Edge, are dependent on certain provisions of the 1996 Telecommunications Act to procure facilities and services from ILECs that are necessary to provide their services. The business of New Edge is highly dependent on rules and rulings from the FCC, legislative actions at both the state and federal level, and rulings from the state public utility commissions. New Edge also must contribute to state and federal universal service funds. In addition, New

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Edge makes use of the special access services and DSL services of ILECs and other CLECs in order to provide New Edge services to its customers.

VoIP Regulation

        We offer voice services to our customers through a fixed line VoIP service and a nomadic-style VoIP service. The current regulatory environment for VoIP services remains unclear, as the decision whether VoIP is an "information service" or "telecommunications service" is still pending. Classifying VoIP as a telecommunications service could require the service provider to obtain a telecommunications license, comply with numerous legacy telephone regulations, and possibly subject the VoIP traffic to inter-carrier access charges, which could result in increased costs. In addition, we currently must comply with seven distinct regulatory obligations imposed by the FCC on VoIP services that interconnect with the public switched telephone network ("PSTN"): (i) access to emergency calling; (ii) compliance with Communications Assistance with Law Enforcement Act ("CALEA"); (iii) payments to the federal universal service fund on interstate revenue; (iv) compliance with rules for disability access; (v) payments for regulatory fees; (vi) compliance with customer proprietary network information ("CPNI") procedures; and (vii) compliance with number portability rules.

Proprietary Rights

        Our EarthLink, PeoplePC and New Edge Networks trademarks are valuable assets to our business, and are registered trademarks in the United States. In particular, we believe the strength of the EarthLink brand among existing and potential customers is important to the success of our business. Additionally, our EarthLink, PeoplePC and New Edge Networks service marks, proprietary technologies, domain names and similar intellectual property are also important to the success of our business. Although we do have several patents, we do not consider these patents important to our business. We principally rely upon trademark law as well as contractual restrictions to establish and protect our technology and proprietary rights and information. We require employees and consultants and, when possible, suppliers and distributors to sign confidentiality agreements, and we generally control access to, and distribution of, our technologies, documentation and other proprietary information. We will continue to assess appropriate occasions for seeking trademark and other intellectual property protections for those aspects of our business and technology that we believe constitute innovations providing us with a competitive advantage. From time to time, third parties have alleged that certain of our technologies infringe on their intellectual property rights. To date, none of these claims has had an adverse effect on our ability to market and sell our services.

Employees

        As of December 31, 2009, we had 623 employees, including 333 operations and customer support personnel, 178 sales and marketing personnel and 112 administrative personnel. As of December 31, 2009, our Consumer Services segment consisted of 339 employees and our Business Services segment consisted of 284 employees. None of our employees are represented by a labor union, and we have no collective bargaining agreement.

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Available Information

        We file annual reports, quarterly reports, current reports, proxy statements and other documents with the Securities and 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 the SEC at the SEC's Public Reference Room at 100 F Street, NE, Washington, DC 20549. The public may obtain information on the operation of the Public Reference Room by calling the SEC at (202) 942-8090. Also, the SEC maintains an Internet web site that contains reports, proxy and information statements, and other information regarding issuers, including EarthLink, that file electronically with the SEC. The public can obtain any documents that we file with the SEC at http://www.sec.gov.

        We also make available free of charge on or through our 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) of the Securities Exchange Act of 1934, as amended, as well as Section 16 reports filed on Forms 3, 4 and 5, as soon as reasonably practicable after we electronically file such material with, or furnish it to, the SEC. Our Internet web site is not meant to be incorporated by reference into this Annual Report on Form 10-K.

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

    Investor Relations
    EarthLink, Inc.
    1375 Peachtree Street
    Atlanta, GA 30309

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Item 1A.    Risk Factors.

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

Risks Related to Our Business and Industry

The continued decline of our consumer access subscribers, combined with the change in mix of our consumer access subscriber base from narrowband to broadband, will adversely affect our results of operations.

        Our consumer access revenues consist primarily of narrowband access revenues and broadband access revenues. Our narrowband subscriber base and revenues have been declining and are expected to continue to decline due to continued maturation of the market for narrowband access, increased availability and reduced pricing of broadband access services and an increase in advanced applications such as music downloads, videos, online gaming and social networking which require greater bandwidth for optimal performance. In addition, our narrowband subscriber base and revenues have been adversely impacted by the effects of our refocused strategy announced in 2007, which resulted in significantly reducing our sales and marketing efforts and focusing instead on retaining customers and adding customers that are more likely to produce an acceptable rate of return. Our broadband subscriber base and revenues have also been declining due to our refocused strategy and due to increased competition among broadband providers. We expect our consumer access subscriber base and revenues to continue to decline, which will adversely affect our profitability and results of operations. If we do not maintain our relationships with current customers or acquire new customers, our revenues will decline and our profitability will be adversely affected.

        Changes in the mix of our consumer access subscriber base, from narrowband access to broadband access, have also negatively affected our consumer access profitability. Our consumer broadband access services have lower gross margins due to the higher costs associated with delivering broadband services. Our ability to provide these services profitably is dependent upon cost-effectively purchasing wholesale broadband access and managing the costs associated with delivering broadband services. While we continuously evaluate cost reduction opportunities associated with the delivery of broadband access services, our overall profitability will be adversely affected if we are unable to continue to manage and reduce costs associated with the delivery of broadband services.

We will have less ability in the future to implement cost reduction initiatives to offset our revenue declines, which will adversely affect our results of operations.

        We have implemented significant cost reduction initiatives to align costs with trends in our revenues, including reducing our headcount, outsourcing certain functions, streamlining internal processes, renegotiating contacts with network service providers and consolidating or closing certain facilities. We plan to continue to implement cost reduction initiatives and to manage our business more efficiently. However, we believe that large-scale cost reduction opportunities will be more limited in the future and in some cases, we may incur upfront costs in connection with implementing certain initiatives. Although we seek to align our cost structure with trends in our revenue, we do not expect to be able to reduce our cost structure to the same extent as our revenue declines and our cost reduction initiatives might not yield the anticipated benefits. If we do not recognize the anticipated benefits of our cost reduction initiatives, or do so in a timely manner, our profitability and cash flows will decline.

We face significant competition that could reduce our profitability.

        We face significant competition in the markets in which we operate and we expect this competition to intensify. The intense competition from our competitors could cause us to decrease the pricing of our

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services, increase churn of our existing customers, increase operating costs or decrease the number of subscribers we are able to add, which would result in lower revenues and profits.

Consumer Services Segment

        Access and service.     We operate in the Internet access services market, which is extremely competitive. We compete directly or indirectly with established online services companies, such as AOL and the Microsoft Network; national communications companies and local exchange carriers, such as AT&T, Qwest and Verizon; cable companies providing broadband access, including Charter Communications, Inc., Comcast, Cox Communications, Inc. and Time Warner Cable; local and regional ISPs; free or value-priced ISPs, such as United Online, Inc. which provides service under the brands Juno and NetZero; wireless Internet service providers; content companies, such as Google and Yahoo!; and satellite and fixed wireless service providers. Competitors for our VoIP services include established telecommunications and cable companies; ISPs; leading Internet companies; and companies that offer VoIP services as their primary business, such as Vonage. Current and prospective competitors include many large companies that have substantially greater market presence and greater financial, technical, marketing and other resources than we have. Competition in the market for access services is likely to continue increasing, and competition could cause us to decrease the pricing of our services, increase churn of our existing customers, increase operating costs or decrease the number of subscribers we are able to add.

        We experience pricing pressures for certain of our consumer access services, particularly our consumer broadband services, due to competition, volume-based pricing and other factors. Some providers have reduced and may continue to reduce the retail price of their Internet access services to maintain or increase their market share, which could cause us to reduce, or prevent us from raising, our prices. We may encounter further market pressures to: migrate existing customers to lower-priced service offerings; restructure service offerings to offer more value; reduce prices; and respond to particular short-term, market-specific situations, such as special introductory pricing or new product or service offerings. Any of the above could adversely affect our revenues and profitability.

        We believe the primary competitive factors in the Internet access service industry are price, speed, features, coverage area and quality of service. While we believe our Internet access services compete favorably based on some of these factors when compared to some Internet access providers, we are at a competitive disadvantage relative to some or all of these factors with respect to some of our competitors. Our dial-up Internet access services do not compete favorably with broadband services with respect to speed, and dial-up Internet access services no longer have a significant, if any, price advantage over certain broadband services. Most of the largest providers of broadband services, such as cable and telecommunications companies, control their own networks and offer a wider variety of services than we offer, including voice, data and video services. Their ability to bundle services and to offer broadband services at prices below the price that we can profitably offer comparable services puts us at a competitive disadvantage.

        Value-added services.     The companies we compete with for Internet access services also compete with us for subscribers to value-added services, such as email storage and security products. We compete for advertising revenues with major ISPs, content providers, large web publishers, web search engine and portal companies, Internet advertising providers, content aggregation companies, social-networking web sites, and various other companies that facilitate Internet advertising. Competition in the market for value-added services may impact the rates we charge.

Business Services Segment

        Through New Edge, we build and manage IP-based wide area networks for businesses and communications carriers. We also provide Internet access to business customers. We face significant

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competition in these markets and we expect this competition to intensify. These markets are rapidly changing due to industry consolidation, an evolving regulatory environment and the emergence of new technologies. We compete directly or indirectly with ILECs, such as AT&T, Qwest and Verizon; other competitive telecommunications companies, such as Covad, Level 3, Megapath and XO Holdings; interexchange carriers, such as Sprint Nextel; wireless and satellite service providers; and cable service providers, such as Charter Communications, Inc., Comcast, Cox Communications, Inc. and Time Warner Cable. We believe the primary competitive factors in our business markets include price, availability, reliability of service, network security, variety of service offerings, quality of service and reputation of the service provider. While we believe our business services compete favorably based on some of these factors, we are at a competitive disadvantage relative to some or all of these factors with respect to some of our competitors. The market for telecommunications services, particularly local exchange services, remains dominated by the ILECs, each of which owns the majority of the local exchange network in its respective operating region of the U.S. Each ILEC has significantly more resources available to expand its penetration within the operating regions where we compete. In addition, industry consolidation has resulted in larger competitors that have greater economies of scale. Additionally, new competitors such as VoIP providers and cable companies have entered the market to compete with traditional, facilities-based telecommunications services providers. The operating results of our Business Services segment may be adversely affected by increased subscriber acquisition and retention costs necessary to attract and retain subscribers in a difficult economic environment.

        We also provide web hosting services to enable customers to build and maintain an effective online presence. The web hosting market is highly fragmented, has low barriers to entry and is characterized by considerable competition on price and features. We compete directly or indirectly with a number of companies, such as GoDaddy.com, Rackspace Hosting, Inc., Web.com and Yahoo!. Some of these companies have substantially greater market presence and greater financial, technical, marketing and other resources than we have. Competition could cause us to decrease the pricing of our services, increase churn of our existing customers, increase operating costs or decrease the number of subscribers we are able to add, which would result in lower revenues and profits.

Adverse economic conditions may harm our business.

        Unfavorable economic conditions, including recession and disruptions to the credit and financial markets, could cause customers to slow spending. Our consumer access services are discretionary and dependent upon levels of consumer spending. In addition, our business customers are particularly exposed to a weak economy. Diminished corporate spending, corporate downsizing and tightened credit have had, and may continue to have, an adverse effect on revenues and churn rates, and have resulted in, and may continue to result in, increased business customer demands for price reductions in connection with contract renewals. In addition, during challenging economic times our business customers may face issues gaining timely access to sufficient credit, which may impair the ability of our customers to pay for services they have purchased. Any of the above could cause us to increase our allowance for doubtful accounts and write-offs of accounts receivable, to impair amounts capitalized as intangible assets, or otherwise have a material adverse effect on our business, financial position, results of operations and cash flows. Finally, our cash, cash equivalents and marketable securities are subject to general credit, liquidity, market, and interest rate risks, which may be exacerbated by unfavorable economic conditions. If financial markets experience prolonged periods of decline, the value or liquidity of our cash, cash equivalents and marketable securities could decline and result in an other-than-temporary decline in fair value, which could adversely affect our financial condition and operating results.

        We are also susceptible to risks associated with the potential financial instability of the vendors and third parties on which we rely to provide services or to which we outsource certain functions. The economic conditions that may affect our customers also could adversely affect vendors and third parties and lead to significant increases in prices, reduction in quality or the bankruptcy of our vendors or third

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parties upon which we rely. Any interruption in the services provided by our vendors or by third parties could adversely affect our business, financial position, results of operations and cash flows.

We may not be able to execute our business strategy for our Business Services segment, which could adversely impact our results of operations and cash flows.

        Revenues for our Business Services segment, which primarily consist of New Edge revenues, have been declining due to economic and competitive pressures. This decline in revenue impacts our ability to leverage our fixed cost network infrastructure. New Edge has a network and cost structure designed to support a larger revenue stream. We are continuing to evaluate ways to create more scale in our New Edge business, and are closely managing operating costs and expenses. However, to achieve and sustain operating profitability in our business services segment, we must generate revenue growth, align our cost structure with revenue trends and otherwise manage this business efficiently. In addition, in order to generate revenue growth, we could incur significant upfront costs to acquire new customers. There can be no assurance that we will be able to reduce our operating expenses commensurate with the revenue decline or create more scale in this business. The inability to reduce operating expenses or create scale could have an adverse impact on our business, financial condition, results of operations and cash flows.

Our commercial and alliance arrangements may not be renewed or may not generate expected benefits, which could adversely affect our results of operations.

        A significant number of our new subscribers have been generated through strategic alliances, including through our marketing alliance with Time Warner Cable and Bright House Networks. Generally, our strategic alliances and marketing relationships are not exclusive and may have a short term. In addition, as our agreements expire or otherwise terminate we may be unable to renew or replace these agreements on comparable terms, or at all. Our inability to maintain our marketing relationships or establish new marketing relationships could result in delays and increased costs in adding paying subscribers and adversely affect our ability to add new customers, which could, in turn, have a material adverse effect on us. The number of customers we are able to add through these marketing relationships is dependent on the marketing efforts of our partners, and there is no commitment for these partners to provide us with new customers. A significant decrease in the number of gross subscriber additions generated through these relationships could adversely affect the size of our customer base and revenues.

Our business is dependent on the availability of third-party telecommunications service providers.

        Our business depends on the capacity, affordability, reliability and security of third-party telecommunications service providers. Only a small number of providers offer the network services we require, and the majority of our telecommunications services are currently purchased from a limited number of telecommunications service providers. Our principal provider for narrowband services is Level 3. Our largest providers of broadband connectivity are AT&T, Comcast, Covad, Qwest, Time Warner Cable and Verizon. We also purchase narrowband services from certain regional and local providers. Telecommunications service providers have merged and may continue to merge, which would reduce the number of suppliers from which we could purchase telecommunications services.

        We cannot be certain of renewal or non-termination of our contracts or that legislative or regulatory factors will not affect our contracts. Our results of operations could be materially adversely affected if we are unable to renew or extend contracts with our current network providers on acceptable terms, renew or extend current contracts with our network providers at all, acquire similar network capacity from other network providers, or otherwise maintain or extend our footprint. Additionally, each of our network providers sells network access to some of our competitors and could choose to grant those competitors preferential network access or pricing. Many of our network providers compete with us in the market to provide consumer Internet access. Such events may cause us to incur additional costs, pay increased rates for wholesale access services, increase the retail prices of our service offerings and/or discontinue providing

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retail access services, any of which could adversely affect our ability to compete in the market for retail access services.

We may be unable to retain sufficient qualified personnel, and the loss of any of our key executive officers could adversely affect us.

        Our business depends on the continued services of our senior management and other key personnel and our ability to effectively retain and motivate them. We have implemented various reductions in workforce over the past few years to streamline our business and improve our cost structure. We expect to continue to implement workforce and cost reduction initiatives. This may affect our ability to retain or replace key personnel, harm employee morale and productivity or disrupt our business. In addition, the reductions in workforce have resulted in less redundancy of mission critical roles. Effective succession planning is important to our long-term success. Failure to ensure effective transfer of knowledge and transitions involving key employees could hinder execution of our business strategies. Finally, the loss of any of our key executives could have a material adverse effect on us.

We may be unsuccessful in making and integrating acquisitions into our business, which could result in operating difficulties, losses and other adverse consequences.

        In the past, we have acquired businesses, technologies, subscriber bases from ISPs, services, products and other assets, including our acquisition of New Edge and PeoplePC. We expect to continue to evaluate and consider potential strategic transactions that we believe may complement our business. At any given time, we may be engaged in discussions or negotiations with respect to one or more of such transactions that may be material to our financial condition and results of operations. There can be no assurance that any such discussions or negotiations will result in the consummation of any transaction.

        These transactions involve significant challenges and risks including diversion of management's attention from our other businesses; the impact on employee morale and retention; the integration of new employees, business systems and technology; the need to implement controls, procedures and policies or the need to remediate significant control deficiencies that may exist at acquired companies; potential unknown liabilities; or any other unforeseen operating difficulties. These factors could adversely affect our operating results or financial condition.

        We may not realize the anticipated benefits of acquisitions or we may not realize them in the time frame expected. Additionally, future acquisitions may result in the dilutive issuances of equity securities, use of our cash resources, incurrence of debt or contingent liabilities, amortization expense related to acquired definite-lived intangible assets or the potential impairment of amounts capitalized as intangible assets, including goodwill. Any of these items could have a material adverse affect on our business, financial condition, results of operations and cash flows.

If we do not continue to innovate and provide products and services that are useful to subscribers, we may not remain competitive, and our revenues and operating results could suffer.

        The market for Internet and telecommunications services is characterized by changing technology, changes in customer needs and frequent new service and product introductions. Our future success will depend, in part, on our ability to use leading technologies effectively, to continue to develop our technical expertise, to enhance our existing services and to develop new services that meet changing customer needs on a timely and cost-effective basis. We may not be able to adapt quickly enough to changing technology, customer requirements and industry standards. Such changes could include acceleration of the adoption of broadband due to government funding to deploy broadband to rural areas. If we fail to use new technologies effectively, to develop our technical expertise and new services, or to enhance existing services on a timely basis, either internally or through arrangements with third parties, our product and service offerings may fail to meet customer needs which could adversely affect our revenues and profitability.

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        Our dial-up Internet access services also rely on their compatibility with other third-party systems and products, including operating systems. Incompatibility with third-party systems and products could adversely affect our ability to deliver our services or a user's ability to access our services. Our dial-up services are dependent on dial-up modems and an increasing number of computer manufacturers do not pre-load their new computers with dial-up modems, requiring the user to separately acquire a modem to access our services. There can be no assurance that, as the dial-up Internet access market declines and new technologies emerge, we will be able to continue to effectively distribute and deliver our dial-up services.

Our business may suffer if third parties used for customer service and technical support and certain billing services are unable to provide these services or terminate their relationships with us.

        Our business and financial results depend, in part, on the availability and quality of our customer service and technical support and certain billing services, including collection services. We outsource a majority of our customer service and technical support functions. As a result, we maintain only a small number of internal customer service and technical support personnel. Our Consumer Services segment relies primarily on one customer service and technical support vendor. We are not currently equipped to provide the necessary range of service and support functions in the event that our service providers becomes unable or unwilling to offer these services to us. Our outsourced customer support providers utilize internationally geographically dispersed locations to provide us with customer service and technical support services, and as a result, our customer support providers may become subject to financial, economic, environmental and political risks beyond our or the providers' control, which could jeopardize their ability to deliver customer service and technical support services. We also utilize third parties for certain billing and collection services. If one or more of our service providers does not provide us with quality services, or if our relationship with any of our third party vendors terminates and we are unable to provide those services internally or identify a replacement vendor in an orderly, cost-effective and timely manner, our business, financial position, results of operations and cash flows could suffer.

Interruption or failure of our network and information systems and other technologies could impair our ability to provide our services, which could damage our reputation and harm our operating results.

        We depend on network and information systems and other technologies, including those at our technology centers and those of our third party service providers. We may experience service interruptions or system failures in the future. In addition, as we consider potential outsource or network consolidation opportunities, we may experience service interruptions despite our efforts to minimize the impact to customers. Any service interruption adversely affects our ability to operate our business and could result in an immediate loss of revenues. If we experience frequent or persistent system or network failures, our reputation and brand could be permanently harmed. We may make significant capital expenditures to increase the reliability of our systems, but these capital expenditures may not achieve the results we expect. Our systems are vulnerable to damage or interruption from earthquakes and other natural disasters, terrorist attacks, floods, fires, power loss, telecommunications failures, break ins, computer denial of service attacks, computer hackings, computer viruses, worms or other attempts to harm our systems, and similar events. Some of our systems are not fully redundant, and our disaster recovery planning may not be adequate. Further, any security breaches, such as misappropriation, misuse, leakage, falsification or accidental release or loss of information maintained in our information technology systems and networks, including customer, personnel and vendor data, could damage our reputation and require us to expend significant capital and other resources to remedy any such security breach. The occurrence of any such network or information system-related events or security breaches could have a material adverse effect on our business, financial position, results of operations and cash flows.

        In addition, our VoIP services, including our E911 service, depend on the proper functioning of facilities and equipment owned and operated by third parties and is, therefore, beyond our control. If our third party service providers fail to maintain these facilities properly, or fail to respond quickly to

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problems, our customers may experience service interruptions. In addition, our E911 emergency service for our VoIP services is different in significant respects from the emergency calling services offered by traditional wireline telephone companies. Those differences may cause significant delays, or even failures, in callers' receipt of the emergency assistance they need. VoIP providers are not currently protected by legislation, so any resulting liability could be substantial. If interruptions or delays adversely affect the perceived reliability of our service, we may have difficulty attracting new customers and our brand and reputation may be negatively impacted. Any of these factors could cause us to lose revenues, incur greater expenses or cause our reputation or financial results to suffer.

Government regulations could adversely affect our business or force us to change our business practices.

        The regulatory environment relating to our business continues to evolve. A number of legislative and regulatory proposals under consideration by federal, state and local governmental entities may lead to the repeal, modification or introduction of laws or regulations which do, or could, affect our business. Our results of operations could be materially adversely affected by future changes of legal and regulatory rights or obligations.

        Narrowband Internet access.     Currently, narrowband Internet access is classified as an "information service" and is not subject to traditional telecommunications services regulation, such as licensing or pricing regulation. Any change to these rules that would apply per-minute carrier access charges to dial-up Internet access traffic could significantly impact our costs for this service. While Internet traffic is not subject to the FCC's carrier access charge regime, dial-up ISP bound traffic is regulated by the FCC. The FCC has established a uniform, nationwide rate for ISP-bound traffic, but these rules have been criticized by the courts and further judicial scrutiny is expected. Changes to the rules governing dial-up ISP bound traffic could impact our cost of providing this service.

        Broadband Internet access.     Currently, broadband Internet access is classified as an "information service" and, as a result, cable companies and telephone companies that offer a broadband Internet access information service are not required by the FCC to offer unaffiliated ISPs stand-alone broadband transmission. Accordingly, if our contracts with cable companies and telephone companies were to expire and not be replaced, our broadband Internet access customer base and revenues would be adversely affected.

        Forbearance.     The Communications Act of 1934, as amended, provides the FCC with the authority to not enforce, or "forbear" from enforcing, statutory requirements and regulations if certain public interest factors are satisfied. If the FCC were to forbear from enforcing regulations that have been established to enable competing broadband Internet access and VoIP, our business could be adversely affected. We expect reform to the FCC's forbearance review process in the near future. The FCC has initiated a proceeding to establish strict evidentiary and filing procedures for review of forbearance petitions.

        Internet taxation.     The Internet Tax Non-Discrimination Act, which is in effect through November 2014, places a moratorium on taxes on Internet access and multiple, discriminatory taxes on electronic commerce. Certain states have enacted various taxes on Internet access and electronic commerce, and selected states' taxes are being contested on a variety of bases. If these state tax laws are not successfully contested, or if future state and federal laws imposing taxes or other regulations on Internet access and electronic commerce are adopted, our cost of providing Internet access services could be increased and our business could be adversely affected.

        Consumer protection.     Federal and state governments have adopted consumer protection laws and undertaken enforcement actions to address advertising and user privacy. As part of these efforts, the Federal Trade Commission ("FTC") and some state Attorney General offices have conducted investigations into the privacy practices of companies that collect information about individuals on the Internet. The FTC and various state agencies as well as individuals have investigated and asserted claims against, or instituted inquiries into, ISPs in connection with marketing, billing, customer retention, cancellation and disclosure practices. Our services and business practices, or changes to our services and business practices could subject us to investigation or enforcement actions if we fail to adequately comply with applicable consumer protection laws.

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        Universal Service.     While current policy exempts broadband access services from the Universal Service Fund ("USF"), the Congress and FCC may consider expanding the USF to include broadband Internet access services. This change could allow broadband service providers to receive a subsidy for deploying broadband in rural and underserved areas, but it will most likely require broadband service providers to contribute to the fund as well. If broadband Internet access providers become subject to USF contribution obligations, they would likely impose a USF surcharge on end users. Such a surcharge will raise the effective cost of our broadband services to our customers, and could adversely affect customer satisfaction or our revenues and profitability.

        CLEC regulation.     New Edge is a CLEC that is licensed in most states and subject to both state and federal telecommunications regulation. CLECs, like New Edge, are dependent on certain provisions of the 1996 Telecommunications Act to procure facilities and services from ILECs that are necessary to provide their services. The business of New Edge is highly dependent on rules and rulings from the FCC, legislative actions at both the state and federal level, and rulings from the state public utility commissions. New Edge also must contribute to state and federal universal service funds. In addition, New Edge makes use of the special access services and DSL services of ILECs and other CLECs in order to provide New Edge services to its customers.

        VoIP regulation.     The current regulatory environment for VoIP services remains unclear, as the decision whether VoIP is an "information service" or "telecommunications service" is still pending. Classifying VoIP as a telecommunications service could require us to obtain a telecommunications license, comply with numerous legacy telephone regulations, and possibly subject the VoIP traffic to inter-carrier access charges, which could result in increased costs.

        Other laws and regulations.     Our business also is subject to a variety of other U.S. laws and regulations that could subject us to liabilities, claims or other remedies, such as laws relating to bulk email or "spam," access to various types of content by minors, anti-spyware initiatives, encryption, data protection, data retention and security breaches. Compliance with these laws and regulations is complex and may require significant costs. In addition, the regulatory framework relating to Internet services is evolving and both the federal government and states from time to time pass legislation that impacts our business. It is likely that additional laws and regulations will be adopted that would affect our business. We cannot predict the impact future laws, regulatory changes or developments may have on our business, financial condition, results of operations or cash flows. The enactment of any additional laws or regulations, increased enforcement activity of existing laws and regulations, or claims by individuals could significantly impact our costs or the manner in which we conduct business, all of which could adversely impact our results of operations and cause our business to suffer.

Privacy concerns relating to our business could damage our reputation and deter current and potential users from using our services.

        Concerns about our practices with regard to the collection, use, disclosure or security of personal information or other privacy-related matters, even if unfounded, could damage our reputation and operating results. We strive to comply with all applicable data protection laws and regulations, as well as our own posted privacy policies. However, any failure or perceived failure to comply with these laws, regulations or policies may result in proceedings or actions against us by government entities or others, which could potentially have an adverse effect on our business.

        In addition, as our services are web-based, we store a substantial amount of data on our servers for customers (including personal information). Any systems failure or compromise of our security that results in the release of our users' data could increase subscriber churn as well as limit our ability to attract new customers by damaging our reputation and brand. We may also need to expend significant resources to protect against security breaches.

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We may not be able to protect our intellectual property.

        We regard our EarthLink, PeoplePC and New Edge Networks trademarks as valuable assets to our business. In particular, we believe the strength of the EarthLink brand among existing and potential customers is important to the success of our business. Additionally, our EarthLink, PeoplePC and New Edge Networks service marks, proprietary technologies, domain names and similar intellectual property are also important to the success of our business. We principally rely upon trademark law as well as contractual restrictions to establish and protect our technology and proprietary rights and information. We require employees and consultants and, when possible, suppliers and distributors to sign confidentiality agreements, and we generally control access to, and distribution of, our technologies, documentation and other proprietary information. The efforts we have taken to protect our proprietary rights may not be sufficient or effective. Third parties may infringe or misappropriate our trademarks and similar proprietary rights. If we are unable to protect our proprietary rights from unauthorized use, our brand image may be harmed and our business may suffer. In addition, protecting our intellectual property and other proprietary rights is expensive and time consuming. Any increase in the unauthorized use of our intellectual property could make it more expensive to do business and consequently harm our operating results.

We may be accused of infringing upon the intellectual property rights of third parties, which is costly to defend and could limit our ability to use certain technologies in the future.

        From time to time, third parties have alleged that we infringe on their intellectual property rights. We have been subject to, and expect to continue to be subject to, claims and legal proceedings regarding alleged infringement by us of the patents, trademarks and other intellectual property rights of third parties. None of these claims has had an adverse effect on our ability to market and sell and support our services. Such claims, whether or not meritorious, are time-consuming and costly to resolve, and could require expensive changes in our methods of doing business, could require us to enter into costly royalty or licensing agreements, or could require us to cease conducting certain operations. Any of these events could result in increases in operating expenses or could limit or reduce the number of our service offerings.

If we are unable to successfully defend against legal actions, we could face substantial liabilities.

        We are currently a party to various legal actions, including consumer class action and patent litigation. Defending against these lawsuits may involve significant expense and diversion of management's attention and resources from other matters. Due to the inherent uncertainties of litigation, we may not prevail in these actions. In addition, our ongoing operations may subject us to litigation risks and costs in the future. Both the costs of defending lawsuits and any settlements or judgments against us could materially and adversely affect our results of operations.

Our business depends on effective business support systems, processes and personnel.

        Our business relies on our data, billing and other operational and financial reporting and control systems. To effectively manage our technical support infrastructure, we will need to continue to maintain our data, billing, and other operational and financial systems, procedures and controls, which can be costly. We have experienced system failures from time to time, and any interruption in the availability of our business support systems, in particular our billing system, could result in an immediate, and possibly substantial, loss of revenues. Frequent or persistent system failures could cause customers to believe our systems are unreliable, leading them to switch to our competitors and could permanently harm our reputation.

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As a result of our continuing review of our business, we may have to undertake further restructuring plans that would require additional charges, including incurring facility exit and restructuring charges.

        Over the past few years, we implemented a corporate restructuring plan under which we significantly reduced our workforce and closed or consolidated various facilities. We also completed the divestiture of our municipal wireless broadband operations. We continue to evaluate our business, which may result in additional restructuring activities or changes in estimates to amounts previously recorded. We may choose to divest certain business operations based on our management's assessment of their strategic value to our business, further consolidate or close certain facilities or outsource certain functions. Decisions to eliminate or limit certain business operations in the future could involve the expenditure of capital, consumption of management resources, realization of losses, transition and wind-up expenses, further reduction in workforce, impairment of the value of purchased assets, facility consolidation and the elimination of revenues along with associated costs, any of which could cause our operating results to decline and may fail to yield the expected benefits. Engaging in further restructuring activities could result in additional charges and costs, including facility exit and restructuring costs, and could adversely affect our business, financial position, results of operations and cash flows.

We may be required to recognize additional impairment charges on our goodwill and intangible assets, which would adversely affect our results of operations and financial position.

        We have recorded goodwill and other intangible assets in connection with our acquisitions. We perform an impairment test of our goodwill and indefinite-lived intangible assets annually during the fourth quarter of our fiscal year or when events occur or circumstances change that would more likely than not indicate that goodwill or any such assets might be impaired. We evaluate the recoverability of our definite-lived intangible assets for impairment when events occur or circumstances change that would indicate that the carrying amount of an asset may not be recoverable. Factors that may be considered a change in circumstances, indicating that the carrying value of our goodwill or intangible assets may not be recoverable, include a decline in stock price and market capitalization, reduced future cash flow estimates, and slower growth rates in our industry. We have experienced impairment charges in the past, and recognized an impairment charge of $24.1 million during the fourth quarter of 2009 related to our Business Services segment. As a result, there is no remaining carrying value related to Business Services goodwill. As we continue to assess the ongoing expected cash flows and carrying amounts of our remaining goodwill and other intangible assets, which relate primarily to our Consumer Services segment, changes in economic conditions, changes to our business strategy, changes in operating performance or other indicators of impairment could cause us to realize a significant impairment charge, negatively impacting our results of operations and financial position.

We may have exposure to greater than anticipated tax liabilities and the use of our net operating losses and certain other tax attributes could be limited in the future.

        As of December 31, 2009, we had approximately $350.0 million of tax net operating losses for federal income tax purposes and approximately $178.0 million of tax net operating losses for state income tax purposes. The tax net operating losses for federal income tax purposes begin to expire in 2020 and the tax net operating losses for state income tax purposes began to expire in 2010.

        Our future income taxes could be adversely affected by changes in the valuation of our deferred tax assets and liabilities or by changes in tax laws, regulations, accounting principles or interpretations thereof. Our determination of our tax liability is always subject to review by applicable tax authorities. Any adverse outcome of such a review could have a negative effect on our operating results and financial condition. In addition, the determination of our provision for income taxes and other tax liabilities requires significant judgment, and there are many transactions and calculations where the ultimate tax determination is uncertain. Although we believe our estimates are reasonable, the ultimate tax outcome may differ from the

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amounts recorded in our financial statements and may materially affect our financial results in the period or periods for which such determination is made.

        Currently, our tax net operating losses can accumulate and be used to offset any of our future taxable income. However, an "ownership change" that occurs during a "testing period" (as such terms are defined in Section 382 of the Internal Revenue Code of 1986, as amended) could place significant limitations, on an annual basis, on the use of such net operating losses to offset future taxable income we may generate. In general, future stock transactions and the timing of such transactions could cause an "ownership change" for income tax purposes. Such transactions may include our purchases under our share repurchase program, additional issuances of common stock by us (including but not limited to issuances upon future conversion of our outstanding convertible senior notes), and acquisitions or sales of shares by certain holders of our shares, including persons who have held, currently hold, or may accumulate in the future five percent or more of our outstanding stock. Many of these transactions are beyond our control. Calculations of an "ownership change" under Section 382 are complex and to some extent are dependent on information that is not publicly available. The risk of an "ownership change" occurring could increase if additional shares are repurchased, if additional persons acquire five percent or more of our outstanding common stock in the near future and/or current five percent stockholders increase their interest. Due to this risk, we monitor our purchases of additional shares of our common stock. Since an "ownership change" also could result from a change in control of our company, with subsequent annual limitations on the use of our net operating losses, this could discourage a change in control.

Risks Related to Ownership of Our Common Stock

We may change our cash return strategy.

        During 2009, we began paying quarterly cash dividends on our common stock. The payment of future quarterly dividends is discretionary and is subject to determination by our Board of Directors each quarter following its review of our financial condition, results of operations, cash requirements, investment opportunities and such other factors as are deemed relevant by our Board of Directors. Changes in our business needs, including working capital and funding for acquisitions, or a change in tax laws relating to dividends, among other factors, could cause our Board of Directors to decide to reduce, or cease the payment of, dividends in the future. There can be no assurance that we will not decrease or discontinue quarterly cash dividends, and if we do, our stock price could be negatively impacted.

        In addition, we could increase the amount of cash dividends paid to shareholders either through a larger quarterly dividend or a special dividend. This could negatively impact our cash flows and reduce our flexibility to engage in other strategic alternatives, such as acquisitions of other businesses. This also could negatively impact our stock price, and may adversely affect our ability to retain key employees or harm employee morale and productivity. We also could engage in a significant stock buyback which could have similar results.

Our stock price may be volatile.

        The trading price of our common stock may be subject to fluctuations as we review our strategic alternatives or if we were to decide upon a particular alternative, such as a business combination transaction or a specific capital return strategy. Our stock price also may fluctuate in response to other events and factors, such as quarterly variations in results of operations; changes in financial estimates; unstable economic conditions; changes in recommendations or reduced coverage by securities analysts; the operating and stock price performance of other companies that investors may deem comparable to us; and news reports relating to trends in the markets in which we operate or general economic conditions.

        In addition, the stock market in general and the market prices for Internet-related companies have experienced volatility that often has been unrelated to the operating performance of such companies. These broad market and industry fluctuations may adversely affect the price of our stock, regardless of our

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operating performance. Additionally, volatility or a lack of positive performance in our stock price may adversely affect our ability to retain key employees, many of whom have been granted stock incentive awards.

Our indebtedness could adversely affect our financial health and limit our ability to react to changes in our industry.

        As of December 31, 2009, we had $258.8 million outstanding principal amount of 3.25% Convertible Senior Notes Due 2026 (the "Notes"). Our indebtedness could have important consequences to us. For example, it could:

    require us to dedicate a substantial portion of our cash flows from operations to payments on our indebtedness, thereby reducing the availability of our cash flow to fund our business activities;

    limit our ability to secure additional financing, if necessary;

    increase our vulnerability to general adverse economic and industry conditions; and

    limit our flexibility in planning for, or reacting to, changes in our business and the industry in which we operate.

        Holders of the Notes have the 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 change prior to maturity. In addition, under the terms of the indenture governing the Notes, our payment of cash dividends requires an adjustment to the conversion rate for the Notes, and as a result of the adjustment, the Notes may be surrendered for conversion for a period of time between the declaration date and the record date, as defined in the indenture, for the consideration provided for in the indenture. During the year ended December 31, 2009, we began declaring dividends on our common stock, and $3.0 million of Notes were surrendered for conversion in January 2010. The number of holders who require us to repurchase the Notes could increase as we continue to declare dividends. Upon conversion of the Notes, we are required to deliver cash equal to the lesser of the aggregate principal amount of the Notes to be converted and the total conversion obligation. We may use cash, shares of common stock or a combination thereof, at our option, for the remainder, if any, of the conversion obligation. We may not have sufficient funds to make the required cash payment upon conversion or to purchase or repurchase the Notes in cash at such time or the ability to arrange necessary financing on acceptable terms. In addition, the requirement to pay the fundamental change repurchase price, including the related make whole premium, may discourage a change in control of our company.

Provisions of our second restated certificate of incorporation, amended and restated bylaws and other elements of our capital structure could limit our share price and delay a change of management.

        Our second restated certificate of incorporation, amended and restated bylaws and shareholder rights plan contain provisions that could make it more difficult or even prevent a third party from acquiring us without the approval of our incumbent board of directors. These provisions, among other things:

    divide the board of directors into three classes, with members of each class to be elected in staggered three-year terms;

    limit the right of stockholders to call special meetings of stockholders; and

    authorize the board of directors to issue preferred stock in one or more series without any action on the part of stockholders.

        These provisions could limit the price that investors might be willing to pay in the future for shares of our common stock and significantly impede the ability of the holders of our common stock to change management. In addition, we have adopted a rights plan, which has anti-takeover effects. The rights plan, if triggered, could cause substantial dilution to a person or group that attempts to acquire our common

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stock on terms not approved by the board of directors. These provisions and agreements that inhibit or discourage takeover attempts could reduce the market value of our common stock.

Item 1B.    Unresolved Staff Comments.

        None.

Item 2.    Properties.

        We lease various properties in the United States with expiration dates through 2014. We use these properties for operations, data centers and executive and administrative purposes. Our corporate headquarters is in Atlanta, Georgia where we occupy approximately 98,000 square feet under a lease that will expire in 2014. We occupy 55,000 square feet in Pasadena, California for operations and corporate offices under a lease that will expire in 2014 and 53,000 square feet in Vancouver, Washington for operations and corporate offices under a lease that will expire in 2012. We also own a data center facility in Atlanta, Georgia.

        We currently have facilities in excess of our needs, and have entered into or plan to enter into various sublease agreements for our unused office and technical space. We believe the facilities we are retaining are suitable and adequate for our business operations. For additional information regarding our obligations under property leases, see Note 14 in our Notes to Consolidated Financial Statements included in Item 8 of Part II of this Annual Report on Form 10-K.

Item 3.    Legal Proceedings.

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

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

        During the quarter ended December 31, 2009, there were no matters submitted to a vote of security holders.

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PART II

Item 5.    Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.

Market Information

        Our common stock is traded on the Nasdaq Global Market under the symbol "ELNK." The following table sets forth the high and low sale prices for our common stock for the periods indicated, as reported by the Nasdaq Global Market.

 
  EarthLink, Inc.  
 
  High   Low  

Year Ended December 31, 2008

             

First Quarter

  $ 7.94   $ 6.23  

Second Quarter

    10.16     7.51  

Third Quarter

    9.78     7.25  

Fourth Quarter

    8.41     5.52  

Year Ended December 31, 2009

             

First Quarter

  $ 7.83   $ 6.02  

Second Quarter

    8.17     6.43  

Third Quarter

    8.75     7.30  

Fourth Quarter

    8.93     7.92  

Year Ending December 31, 2010

             

First Quarter (through January 29, 2010)

  $ 8.60   $ 8.09  

        The last reported sale price of our common stock on the Nasdaq Global Market on January 29, 2010 was $8.11 per share.

Holders

        There were approximately 1,784 holders of record of our common stock on January 29, 2010.

Dividends

        During 2009, we began paying quarterly cash dividends. In July 2009, our Board of Directors declared a quarterly cash dividend on our common stock of $0.14 per share to stockholders of record on September 14, 2009, which was paid in September 2009 and totaled $15.0 million. In October 2009, our Board of Directors declared a quarterly cash dividend on our common stock of $0.14 per share to stockholders of record on December 9, 2009, which was paid in December 2009 and totaled $15.0 million. In January 2010, our Board of Directors declared a quarterly cash dividend on our common stock of $0.14 per share to stockholders of record on March 12, 2010 to be paid in March 2010. We currently intend to continue to pay regular quarterly dividends on our common stock. Any decision to declare future dividends will be made at the discretion of the Board of Directors and will depend on, among other things, our results of operations, financial condition, cash requirements, investment opportunities and other factors the Board of Directors may deem relevant. Prior to 2009, we had never declared or paid cash dividends on our common stock.

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Performance Graph

        The following indexed line graph indicates our total return to stockholders from December 31, 2004 to December 31, 2009, as compared to the total return for the Nasdaq Global Market and the Morgan Stanley Internet Index for the same period. The calculations in the graph assume that $100 was invested on December 31, 2004 in our common stock and each index and also assumes dividend reinvestment.

GRAPHIC

 
  December 31,
2004
  December 31,
2005
  December 31,
2006
  December 31,
2007
  December 31,
2008
  December 31,
2009
 

EarthLink, Inc. 

    100.0     96.4     61.6     61.4     58.7     74.6  

Nasdaq Global Market

    100.0     101.4     111.0     121.9     72.5     104.3  

Morgan Stanley Internet Index

    100.0     100.8     110.3     146.2     79.1     154.8  

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Item 6.    Selected Financial Data.

        The following selected consolidated financial data was derived from our consolidated financial statements. The data should be read in conjunction with "Management's Discussion and Analysis of Financial Condition and Results of Operation" and the consolidated financial statements and notes thereto included elsewhere in this Annual Report on Form 10-K.

 
  Year Ended December 31,  
 
  2005   2006   2007   2008   2009  
 
  (in thousands, except per share amounts)
 

Statement of operations data:

                               

Revenues

  $ 1,290,072   $ 1,301,072   $ 1,215,994   $ 955,577   $ 723,729  

Operating costs and expenses (1)(2)

    1,125,576     1,205,431     1,167,960     790,970     541,571  

Income from operations

    164,496     95,641     48,034     164,607     182,158  

Income (loss) from continuing operations (3)

    142,780     23,690     (64,795 )   187,090     287,118  

Loss from discontinued operations (4)

        (19,999 )   (80,302 )   (8,506 )    

Net income (loss) (3)

    142,780     3,691     (145,097 )   178,584     287,118  

Basic net income (loss) per share

                               
 

Continuing operations

  $ 1.04   $ 0.18   $ (0.53 ) $ 1.71   $ 2.69  
 

Discontinued operations

        (0.16 )   (0.66 )   (0.08 )    
                       
 

Basic net income (loss) per share

  $ 1.04   $ 0.03   $ (1.19 ) $ 1.63   $ 2.69  
                       

Diluted net income (loss) per share

                               
 

Continuing operations

  $ 1.02   $ 0.18   $ (0.53 ) $ 1.68   $ 2.66  
 

Discontinued operations

        (0.15 )   (0.66 )   (0.08 )    
                       
 

Diluted net income (loss) per share

  $ 1.02   $ 0.03   $ (1.19 ) $ 1.61   $ 2.66  
                       

Cash dividends declared per common share

  $   $   $   $   $ 0.28  
                       

Basic weighted average common shares outstanding

    137,080     128,790     121,633     109,531     106,909  
                       

Diluted weighted average common shares outstanding

    139,950     130,583     121,633     111,051     108,084  
                       

Cash flow data:

                               

Cash provided by operating activities

  $ 188,704   $ 115,249     88,789     230,612     208,622  

Cash (used in) provided by investing activities

    (65,081 )   (283,064 )   13,936     107,124     (37,121 )

Cash (used in) provided by financing activities

    (169,239 )   152,890     (87,267 )   (24,999 )   (47,070 )

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  As of December 31,  
 
  2005   2006   2007   2008   2009  
 
  (in thousands)
 

Balance sheet data:

                               

Cash and cash equivalents

  $ 173,294   $ 158,369   $ 173,827   $ 486,564   $ 610,995  

Investments in marketable securities

    248,825     236,407     114,768     47,809     84,966  
                       

Cash and marketable securities

    422,119     394,776     288,595     534,373     695,961  

Total assets

   
749,149
   
966,298
   
729,970
   
845,866
   
1,074,618
 

Long-term debt, including long-term portion of capital leases (5)

    1,067     198,223     208,472     219,733     232,248  

Total liabilities

    227,285     448,616     415,452     359,391     340,594  

Accumulated deficit

    (1,049,982 )   (1,046,293 )   (1,191,390 )   (1,016,833 )   (729,715 )

Stockholders' equity

    521,864     517,682     314,518     486,475     734,024  

(1)
Operating costs and expenses for the years ended December 31, 2008 and 2009 include non-cash impairment charges of $78.7 million and $24.1 million, respectively, related to goodwill and certain intangible assets of New Edge in our Business Services segment. We concluded the carrying value of these assets were impaired in conjunction with our annual tests of goodwill and intangible assets deemed to have indefinite lives.

(2)
During the years ended December 31, 2008 and 2009, we recorded income tax benefits in the Statement of Operations of approximately $56.1 million and $198.8 million, respectively, from releases of our valuation allowance related to deferred tax assets. These deferred tax assets related primarily to net operating loss carryforwards which we determined we will more likely than not be able to utilize due to the generation of sufficient taxable income in the future.

(3)
On January 1, 2009, we adopted new accounting guidance related to accounting for convertible debt instruments that may be settled in cash upon conversion. The new accounting guidance requires that the liability and equity components of convertible debt instruments that may be settled in cash upon conversion (including partial cash settlement) be separately accounted for in a manner that reflects an issuer's non-convertible debt borrowing rate. The resulting debt discount is accreted over the period the convertible debt is expected to be outstanding as additional non-cash interest expense. Retrospective application to all periods presented is required. The adoption of this new guidance on January 1, 2009 affected the accounting for our Convertible Senior Notes due November 15, 2026 (the "Notes"), which were issued in November 2006. As a result of this new guidance, we recognized additional non-cash interest expense of $1.3 million, $10.0 million, $11.0 million and $12.2 million during the years ended December 31, 2006, 2007, 2008 and 2009, respectively, and will recognize additional non-cash interest expense of $13.4 million and $12.4 million during the years ending December 31, 2010 and 2011, respectively.

(4)
In November 2007, management concluded that the municipal wireless broadband operations were no longer consistent with our strategic direction and our Board of Directors authorized management to pursue the divestiture of our municipal wireless broadband assets. As a result of that decision, we classified the municipal wireless broadband assets as held for sale and presented the municipal wireless broadband operations as discontinued operations for all periods presented.

(5)
Includes the carrying amount of our Notes, which was $198.0 million, $208.3 million, $219.7 million and $232.2 million as of December 31, 2006, 2007, 2008 and 2009, respectively. During November 2006, we issued $258.8 million aggregate principal amount of Notes in a registered offering. The Notes are convertible on October 15, 2011 and upon certain events. We have the option to redeem the Notes, in whole or in part, for cash, on or after November 15, 2011, provided that we have made at least ten semi-annual interest payments. In addition, the holders may require us to purchase all or a

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    portion of their Notes on each of November 15, 2011, November 15, 2016 and November 15, 2021. During 2009, we began paying quarterly cash dividends on our common stock. This requires an adjustment to the conversion rate for the Notes and opens a conversion period for holders. As a result, the Notes were classified as a current liability in our Consolidated Balance Sheet as of December 31, 2009.

Item 7.    Management's Discussion and Analysis of Financial Condition and Results of Operation.

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

Safe Harbor Statement

        The Management's Discussion and Analysis and other portions of this Annual Report on Form 10-K include "forward-looking" statements (rather than historical facts) that are subject to risks and uncertainties that could cause actual results to differ materially from those described. Although we believe that the expectations expressed in these forward-looking statements are reasonable, we cannot promise that our expectations will turn out to be correct. Our actual results could be materially different from and worse than our expectations. With respect to such forward-looking statements, we seek the protections afforded by the Private Securities Litigation Reform Act of 1995. These risks include, without limitation (1) that the continued decline of our consumer access subscribers, combined with the change in mix of our consumer access subscriber base from narrowband to broadband, will adversely affect our results of operations; (2) that we will have less ability in the future to implement cost reduction initiatives to offset our revenue declines, which will adversely affect our results of operations; (3) that we face significant competition which could reduce our profitability; (4) that adverse economic conditions may harm our business; (5) that we may not be able to execute our business strategy for our Business Services segment, which could adversely impact our results of operations and cash flows; (6) that our commercial and alliance arrangements may not be renewed or may not generate expected benefits, which could adversely affect our results of operations; (7) that our business is dependent on the availability of third-party telecommunications service providers; (8) that we may be unable to retain sufficient qualified personnel, and the loss of any of our key executive officers could adversely affect us; (9) that we may be unsuccessful in making and integrating acquisitions into our business, which could result in operating difficulties, losses and other adverse consequences; (10) that if we do not continue to innovate and provide products and services that are useful to subscribers, we may not remain competitive, and our revenues and operating results could suffer; (11) that our business may suffer if third parties used for customer service and technical support and certain billing services are unable to provide these services or terminate their relationships with us; (12) that interruption or failure of our network and information systems and other technologies could impair our ability to provide our services, which could damage our reputation and harm our operating results; (13) that government regulations could adversely affect our business or force us to change our business practices; (14) that privacy concerns relating to our business could damage our reputation and deter current and potential users from using our services; (15) that we may not be able to protect our intellectual property; (16) that we may be accused of infringing upon the intellectual property rights of third parties, which is costly to defend and could limit our ability to use certain technologies in the future; (17) that if we are unable to successfully defend against legal actions we could face substantial liabilities; (18) that our business depends on effective business support systems, processes and personnel; (19) that as a result of our continuing review of our business, we may have to undertake further restructuring plans that would require additional charges, including incurring facility exit and restructuring charges; (20) that we may be required to recognize additional impairment charges on our goodwill and intangible assets, which would adversely affect our results of operations and financial position; (21) that we may have exposure to greater than anticipated tax liabilities and the use of our net operating losses and certain other tax attributes could be limited in the future; (22) that we may change our cash return

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strategy; (23) that our stock price may be volatile; (24) that our indebtedness could adversely affect our financial health and limit our ability to react to changes in our industry; and (25) that provisions of our second restated certificate of incorporation, amended and restated bylaws and other elements of our capital structure could limit our share price and delay a change of management. These risks and uncertainties are described in greater detail in Item 1A of Part I, "Risk Factors."

Overview

        EarthLink, Inc. is an Internet service provider ("ISP"), providing nationwide Internet access and related value-added services to individual and business customers. Our primary service offerings are dial-up and high-speed Internet access services and related value-added services, such as ancillary services sold as add-on features to our Internet access services, search and advertising. In addition, through our wholly-owned subsidiary, New Edge Networks ("New Edge"), we build and manage IP-based wide area networks for businesses and communications carriers.

        We operate two reportable segments, Consumer Services and Business Services. Our Consumer Services segment provides Internet access and related value-added services to individual customers. These services include dial-up and high-speed Internet access and voice-over-Internet Protocol ("VoIP") services, among others. Our Business Services segment provides integrated communications services and related value-added services to businesses and communications carriers. These services include managed IP-based wide area networks, dedicated Internet access and web hosting, among others.

Business Strategy

        Our business strategy is to maximize the cash flows generated by our business by focusing on customer retention, operational efficiency and opportunities for growth.

    Customer Retention.   We are focused on retaining our customers. We believe focusing on the customer relationship increases loyalty and reduces churn. We also believe that satisfied customers provide cost benefits, including reduced call center support costs and reduced bad debt expense. We continue to focus on offering our access services with high-quality customer service and technical support.

    Operational Efficiency.   We are focused on improving the cost structure of our business and aligning our cost structure with trends in our revenue, without impacting the quality of services we provide. We are focused on delivering our services more cost effectively by reducing and more efficiently handling the number of calls to contact centers, managing cost-effective outsourcing opportunities, managing our network costs, implementing workforce reduction initiatives and streamlining our internal processes and operations.

    Opportunities for Growth.   In response to changes in our business, we have significantly reduced our sales and marketing spending during the past two years. However, we continue to seek to add customers that generate an acceptable rate of return and increase the number of subscribers we add through alliances, partnerships and acquisitions from other ISPs. We continue to evaluate and consider potential strategic transactions that may complement our business. We are also seeking ways to create more scale within our New Edge business.

        The primary challenges we face in executing our business strategy are managing the rate of decline in our revenues, aligning costs with trends in our revenue, responding to competition, reducing churn, purchasing cost-effective network services from third-party telecommunications service providers and adding customers that generate an acceptable rate of return. The factors we believe are instrumental to the achievement of our business strategy may be subject to competitive, regulatory and other events and circumstances that are beyond our control. Further, we can provide no assurance that we will be successful in achieving any or all of the strategies identified above, that the achievement or existence of such

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strategies will favorably impact profitability, or that other factors will not arise that would adversely affect future profitability.

        In response to declining revenues, changes in our industry and changes in consumer behavior, we implemented a restructuring plan ("the 2007 Plan") to reduce operating costs and improve the efficiency of our organization. Under the 2007 Plan, we significantly reduced employees, closed or consolidated certain facilities, discontinued certain projects and reduced sales and marketing efforts. The 2007 Plan was primarily implemented during 2007 and 2008. Costs related to the 2007 Plan are included in facility exit and restructuring costs in our Consolidated Statements of Operations. Subsequent to the 2007 Plan, we implemented further workforce reduction and cost-cutting initiatives. We plan to continue to implement cost reduction initiatives and to better and more efficiently manage costs of our business. Costs related to implementing initiatives subsequent to the 2007 Plan, such as employee severance, are included in sales and marketing, operations and customer support and general and administrative expenses in our Consolidated Statements of Operations.

Revenue Sources

        The primary component of our revenues is access and service revenues, which consist of narrowband access services (including traditional, fully-featured narrowband access and value-priced narrowband access); broadband access services (including high-speed access via DSL and cable; managed IP-based wide area networks; and VoIP); and web hosting services. We also earn revenues from value-added services, which include revenues from ancillary services sold as add-on features to our Internet access services, such as security products, premium email only, home networking, email storage and Internet call waiting; search revenues; and advertising revenues.

        Narrowband access revenues primarily consist of fees charged to customers for dial-up Internet access. Broadband access revenues primarily consist of fees charged for high-speed access services; fees charged for managing IP-based networks; and fees charged for VoIP services. Web hosting revenues consist of fees charged for leasing server space and providing web services that enable customers to build and maintain an effective online presence. Value-added services revenues consist of fees charged for ancillary services; fees charged for paid placements for searches; delivering traffic to EarthLink's partners in the form of subscribers, page views or e-commerce transactions; advertising EarthLink partners' products and services in EarthLink's various online properties and electronic publications; and referring EarthLink customers to partners' products and services.

Trends in our Business

        Consumer services.     We operate in the Internet access market, which is characterized by intense competition, changing technology, changes in customer needs and new service and product introductions. Consumers continue to migrate from dial-up to broadband access service due to the faster connection and download speeds provided by broadband access, the ability to free up their phone lines and the more reliable and "always on" connection. The pricing for broadband services has been declining, making it a more viable option for consumers who continue to rely on dial-up connections for Internet access. In addition, advanced applications such as online gaming, music downloads, videos and social networking require greater bandwidth for optimal performance, which adds to the demand for broadband access. Our narrowband subscriber base and revenues have been declining and are expected to continue to decline due to the continued maturation of the market for narrowband access. Additionally, our consumer access services are discretionary and dependent upon levels of consumer spending. Unfavorable economic conditions could cause customers to slow spending in the future, which could adversely affect our revenues and churn.

        In light of this continued maturation of the market for narrowband access, we refocused our business strategy to significantly reduce our sales and marketing efforts and focus instead on retaining customers

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and adding customers that have similar characteristics as our tenured customer base and are more likely to produce an acceptable rate of return. While this change has resulted in a decline in our revenues, we expect the rate of revenue decline to decrease as our subscriber base becomes more tenured and churn rates decline. Our consumer subscriber churn rates improved from 5.2% during the year ended December 31, 2007, to 4.4% and 3.6% during the years ended December 31, 2008 and 2009, respectively.

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

        Business services.     The markets in which we operate our business services are characterized by industry consolidation, an evolving regulatory environment, the emergence of new technologies and intense competition. We sell our services to end user business customers and to wholesale customers. Our end users range from large enterprises with many locations, to small and medium-sized multi-site businesses to business customers with one site, often a home-based location. Many of our end user customers are retail businesses. Our wholesale customers consist primarily of telecommunications carriers and network resellers. Our business has become more focused on end users as a result of consolidation in the telecommunications industry. In addition, our business customers, including retail businesses, are particularly exposed to a weak economy. We have experienced pressure on revenue and operating expenses for our business services, given the current state of the economy, including increased subscriber acquisition and retention costs necessary to attract and retain subscribers. However, we are seeking ways to grow our business services revenue while operating this segment more efficiently.

2009 Highlights

        Total revenues decreased $231.8 million, or 24%, from the year ended December 31, 2008 to the year ended December 31, 2009, as our subscriber base decreased from approximately 2.8 million paying subscribers as of December 31, 2008 to approximately 2.2 million paying subscribers as of December 31, 2009. The decrease in subscribers was attributable to reduced sales and marketing activities, continued competitive pressures and continued maturation of the narrowband Internet access market. Offsetting the decline in total revenues was a $249.4 million, or 32%, decline in total operating costs and expenses. Total operating costs and expenses decreased as our overall subscriber base has decreased and become longer tenured. Our longer tenured customers require less customer service and technical support and have a lower frequency of non-payment. We also experienced benefits from workforce reduction initiatives and other cost cutting initiatives. The decrease in total operating costs and expenses during the year ended December 31, 2009 compared to the prior year period also reflects a decline in goodwill and intangible asset impairments, which decreased $54.5 million from the year ended December 31, 2008 to the year ended December 31, 2009. Net income increased $108.5 million, or 61%, from $178.6 million during the year ended December 31, 2008 to $287.1 million during the year ended December 31, 2009. The increase in net income reflects the changes noted above, as well as a $93.9 million increase in our income tax benefit, primarily due to an increase in the release of our valuation allowance related to our deferred tax assets, and an $8.5 million decrease in loss from discontinued operations, net of tax.

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Looking Ahead

        We expect total revenues to continue to decrease during 2010 as we continue to reduce our sales and marketing efforts and as the market for Internet access continues to mature. However, we expect the rate of revenue decline to decelerate as our customer base becomes longer tenured and churn rates go down. Consistent with trends in the Internet access industry, we expect the mix of our consumer access subscriber base to continue to shift from narrowband access to broadband access customers, which will negatively affect our profitability due to the higher costs associated with delivering broadband services. We also expect economic conditions to put continued pressure on revenue and churn rates for our business services, and may impact revenue and churn for our consumer services. We will continue to evaluate ways to grow revenues or create more scale for our business services. We expect cost savings in 2010 associated with our decreased sales and marketing activities, and decreased telecommunication and support costs from a lower and longer tenured customer base. We will continue to implement cost reduction initiatives. However, we believe that large-scale cost reduction opportunities will be more limited in the future. In addition, although we seek to align our cost structure with trends in our revenue, we do not expect to be able to reduce our cost structure to the same extent as our revenue declines.

Dividends

        During 2009, we began paying quarterly cash dividends to shareholders. In July 2009, our Board of Directors declared a quarterly cash dividend on our common stock of $0.14 per share to stockholders of record on September 14, 2009. The dividend was paid in September 2009 and totaled $15.0 million. In October 2009, our Board of Directors declared a quarterly cash dividend on our common stock of $0.14 per share to stockholders of record on December 9, 2009. The dividend was paid in December 2009 and totaled $15.0 million. The Board of Directors also approved the payment of cash dividend amounts on each outstanding restricted stock unit to be paid at the time the restricted stock unit vests. We currently intend to continue to pay regular quarterly dividends on our common stock. Any decision to declare future dividends will be made at the discretion of the Board of Directors and will depend on, among other things, our results of operations, financial condition, cash requirements, investment opportunities and other factors the Board of Directors may deem relevant.

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Key Operating Metrics

        We utilize certain non-financial and operating measures to assess our financial performance. Terms such as churn and average revenue per user ("ARPU") are terms commonly used in our industry. The following table sets forth subscriber and operating data for the periods indicated:

 
  December 31,
2007
  December 31,
2008
  December 31,
2009
 

Subscriber Data (a)

                   

Consumer Services

                   
 

Narrowband access subscribers

    2,624,000     1,747,000     1,225,000  
 

Broadband access subscribers

    1,059,000     896,000     804,000  
               
 

Total consumer services subscribers

    3,683,000     2,643,000     2,029,000  

Business Services

                   
 

Narrowband access subscribers

    27,000     17,000     8,000  
 

Broadband access subscribers

    66,000     59,000     54,000  
 

Web hosting accounts

    100,000     87,000     75,000  
               
 

Total business services subscribers

    193,000     163,000     137,000  
               

Total subscribers at end of year

    3,876,000     2,806,000     2,166,000  
               

 

 
  Year Ended December 31,  
 
  2007   2008   2009  

Subscriber Activity

                   

Subscribers at beginning of year

    5,313,000     3,876,000     2,806,000  

Gross organic subscriber additions

    1,994,000     666,000     419,000  

Acquired subscribers

    65,000     8,000      

Adjustment (b)

    (753,000 )   (15,000 )   (7,000 )

Churn

    (2,743,000 )   (1,729,000 )   (1,052,000 )
               

Subscribers at end of year

    3,876,000     2,806,000     2,166,000  
               

Churn rate (c)

    5.1 %   4.4 %   3.6 %

Consumer Services Data

                   

Average subscribers (d)

    4,321,000     3,130,000     2,310,000  

ARPU (e)

  $ 19.77   $ 20.76   $ 20.76  

Churn rate (c)

    5.2 %   4.4 %   3.6 %

Business Services Data

                   

Average subscribers (d)

    207,000     179,000     149,000  

ARPU (e)

  $ 76.62   $ 81.64   $ 82.83  

Churn rate (c)

    2.6 %   2.8 %   2.6 %

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  December 31,
2007
  December 31,
2008
  December 31,
2009
 

Employee Data

                   

Consumer Services

    676     457     339  

Business Services

    307     297     284  
               
 

Total number of employees (f)

    983     754     623  

Operations and customer support

   
499
   
396
   
333
 

Sales and marketing

    302     207     178  

General and administrative

    182     151     112  
               
 

Total number of employees (f)

    983     754     623  

(a)
Subscriber counts do not include nonpaying customers. Customers receiving service under promotional programs that include periods of free service at inception are not included in subscriber counts until they become paying customers.

(b)
We had a marketing relationship with Embarq, a spin-off of Sprint Nextel Corporation's ("Sprint") local communications business, under which EarthLink was the wholesale high-speed ISP for Embarq's local residential and small business customers. In April 2007, our wholesale contract with Embarq expired. As a result, we removed 753,000 wholesale broadband EarthLink-supported Embarq subscribers from our broadband subscriber count and total subscriber count. During the year ended December 31, 2008, we removed 15,000 additional EarthLink-supported Sprint customers from our broadband subscriber counts. During the year ended December 31, 2009, we removed approximately 7,000 satellite subscribers from our broadband subscriber count and total subscriber count as a result of our sale of these subscriber accounts.

(c)
Churn rate is used to measure the rate at which subscribers discontinue service on a voluntary or involuntary basis. Churn rate is computed by dividing the average monthly number of subscribers that discontinued service during the year by the average subscribers for the year. Churn rate for the years ended December 31, 2007, 2008 and 2009 excludes the impact of the adjustments noted in (b) above.

(d)
Average subscribers or accounts is calculated by averaging the ending monthly subscribers or accounts for the thirteen months preceding and including the end of the year.

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

(f)
Represents full-time equivalents.

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Results of Operations

Consolidated Results of Operations

        The following table sets forth statement of operations data for the years ended December 31, 2007 and 2008:

 
  Year Ended December 31,    
   
 
 
  2007   2008   Change Between
2007 and 2008
 
 
   
  % of
Revenue
   
  % of
Revenue
 
 
  Amount   Amount   Amount   %  
 
  (dollars in thousands)
 

Revenues

  $ 1,215,994     100%   $ 955,577     100%   $ (260,417 )   -21%  

Operating costs and expenses:

                                     
 

Cost of revenues

    442,697     36%     360,920     38%     (81,777 )   -18%  
 

Sales and marketing

    291,105     24%     98,212     10%     (192,893 )   -66%  
 

Operations and customer support

    221,443     18%     136,797     14%     (84,646 )   -38%  
 

General and administrative

    128,412     11%     93,878     10%     (34,534 )   -27%  
 

Amortization of intangible assets

    14,672     1%     13,349     1%     (1,323 )   -9%  
 

Impairment of goodwill and intangible assets

    4,250     0%     78,672     8%     74,422     *      
 

Facility exit and restructuring costs

    65,381     5%     9,142     1%     (56,239 )   -86%  
                                 
   

Total operating costs and expenses

    1,167,960     96%     790,970     83%     (376,990 )   -32%  
   

Income from operations

    48,034     4%     164,607     17%     116,573     243%  

Net losses of equity affiliate

    (111,295 )   -9%         0%     111,295     -100%  

Gain (loss) on investments, net

    (5,585 )   0%     2,708     0%     8,293     148%  

Interest income (expense) and other, net

    2,824     0%     (12,409 )   -1%     (15,233 )   539%  
                                 
   

Income (loss) from continuing operations before income taxes

    (66,022 )   -5%     154,906     16%     220,928     335%  

Income tax benefit

    1,227     0%     32,184     3%     30,957     *      
                                 
   

Income (loss) from continuing operations

    (64,795 )   -5%     187,090     20%     251,885     389%  

Loss from discontinued operations, net of tax

    (80,302 )   -7%     (8,506 )   -1%     71,796     -89%  
                                 
   

Net income (loss)

  $ (145,097 )   -12%   $ 178,584     19%   $ 323,681     223%  
                                 

*
denotes percentage is not meaningful or is not calculable

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        The following table sets forth statement of operations data for the years ended December 31, 2008 and 2009:

 
  Year Ended December 31,    
   
 
 
  2008   2009   Change Between
2008 and 2009
 
 
   
  % of
Revenue
   
  % of
Revenue
 
 
  Amount   Amount   Amount   %  
 
  (dollars in thousands)
 

Revenues

  $ 955,577     100%   $ 723,729     100%   $ (231,848 )   -24%  

Operating costs and expenses:

                                     
 

Cost of revenues

    360,920     38%     273,755     38%     (87,165 )   -24%  
 

Sales and marketing

    98,212     10%     59,474     8%     (38,738 )   -39%  
 

Operations and customer support

    136,797     14%     98,435     14%     (38,362 )   -28%  
 

General and administrative

    93,878     10%     72,398     10%     (21,480 )   -23%  
 

Amortization of intangible assets

    13,349     1%     7,749     1%     (5,600 )   -42%  
 

Impairment of goodwill and intangible assets

    78,672     8%     24,145     3%     (54,527 )   -69%  
 

Facility exit and restructuring costs

    9,142     1%     5,615     1%     (3,527 )   -39%  
                                 
   

Total operating costs and expenses

    790,970     83%     541,571     75%     (249,399 )   -32%  
   

Income from operations

    164,607     17%     182,158     25%     17,551     11%  

Gain (loss) on investments, net

    2,708     0%     (1,321 )   0%     (4,029 )   -149%  

Interest expense and other, net

    (12,409 )   -1%     (19,804 )   -3%     (7,395 )   60%  
                                 
   

Income from continuing operations before income taxes

    154,906     16%     161,033     22%     6,127     4%  

Income tax benefit

    32,184     3%     126,085     17%     93,901     292%  
                                 
   

Income from continuing operations

    187,090     20%     287,118     40%     100,028     53%  

Loss from discontinued operations, net of tax

    (8,506 )   -1%         0%     8,506     -100%  
                                 
   

Net income

  $ 178,584     19%   $ 287,118     40%   $ 108,534     61%  
                                 

Segment Results of Operations

        We operate two reportable segments, Consumer Services and Business Services. We present our segment information along the same lines that our chief executive reviews our operating results in assessing performance and allocating resources. Our Consumer Services segment provides Internet access services and related value-added services to individual customers. These services include dial-up and high-speed Internet access and VoIP services, among others. Our Business Services segment provides integrated communications services and related value-added services to businesses and communications carriers. These services include managed IP-based wide area networks, dedicated Internet access and web hosting, among others.

        We evaluate the performance of our operating segments based on segment income from operations. Segment income from operations includes revenues from external customers, related cost of revenues and operating expenses directly attributable to the segment, which include expenses over which segment managers have direct discretionary control, such as advertising and marketing programs, customer support expenses, operations expenses, product development expenses, certain technology and facilities expenses, billing operations and provisions for doubtful accounts. Segment income from operations excludes other income and expense items and certain expenses over which segment managers do not have discretionary control. Costs excluded from segment income from operations include various corporate expenses (consisting of certain costs such as corporate management, human resources, finance and legal), amortization of intangible assets, impairment of goodwill and intangible assets, facility exit and

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restructuring costs and stock-based compensation expense, as they are not considered in the measurement of segment performance.

        The following table set forth segment data for the years ended December 31, 2007, 2008 and 2009:

 
  Year Ended December 31,   2008 vs. 2007   2009 vs. 2008  
 
  2007   2008   2009   $ Change   % Change   $ Change   % Change  
 
  (dollars in thousands)
 

Consumer Services

                                           
 

Revenues

  $ 1,025,408   $ 779,876   $ 575,412   $ (245,532 )   -24%   $ (204,464 )   -26%  
 

Cost of revenues

    324,465     259,851     186,570     (64,614 )   -20%     (73,281 )   -28%  
                                   
 

Gross margin

    700,943     520,025     388,842     (180,918 )   -26%     (131,183 )   -25%  
 

Direct segment operating expenses

    506,975     207,236     131,154     (299,739 )   -59%     (76,082 )   -37%  
                                   
 

Segment operating income

  $ 193,968   $ 312,789   $ 257,688   $ 118,821     61%   $ (55,101 )   -18%  
                                   

Business Services

                                           
 

Revenues

  $ 190,586   $ 175,701   $ 148,317   $ (14,885 )   -8%   $ (27,384 )   -16%  
 

Cost of revenues

    118,232     101,069     87,185     (17,163 )   -15%     (13,884 )   -14%  
                                   
 

Gross margin

    72,354     74,632     61,132     2,278     3%     (13,500 )   -18%  
 

Direct segment operating expenses

    58,548     51,276     41,975     (7,272 )   -12%     (9,301 )   -18%  
                                   
 

Segment operating income

  $ 13,806   $ 23,356   $ 19,157   $ 9,550     69%   $ (4,199 )   -18%  
                                   

Consolidated

                                           
 

Revenues

  $ 1,215,994   $ 955,577   $ 723,729   $ (260,417 )   -21%   $ (231,848 )   -24%  
 

Cost of revenues

    442,697     360,920     273,755     (81,777 )   -18%     (87,165 )   -24%  
                                   
 

Gross margin

    773,297     594,657     449,974     (178,640 )   -23%     (144,683 )   -24%  
 

Direct segment operating expenses

    565,523     258,512     173,129     (307,011 )   -54%     (85,383 )   -33%  
                                   
 

Segment operating income

    207,774     336,145     276,845     128,371     62%     (59,300 )   -18%  
 

Stock-based compensation expense

    19,553     20,133     13,231     580     3%     (6,902 )   -34%  
 

Amortization of intangible assets

    14,672     13,349     7,749     (1,323 )   -9%     (5,600 )   -42%  
 

Impairment of goodwill and intangible assets

    4,250     78,672     24,145     74,422     *     (54,527 )   -69%  
 

Facility exit and restructuring costs

    65,381     9,142     5,615     (56,239 )   -86%     (3,527 )   -39%  
 

Other operating expenses

    55,884     50,242     43,947     (5,642 )   -10%     (6,295 )   -13%  
                                   
 

Income from operations

  $ 48,034   $ 164,607   $ 182,158   $ 116,573     243%   $ 17,551     11%  
                                   

*
denotes percentage is not meaningful or is not calculable

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Revenues

        The following table presents revenues by groups of similar services and by segment for the years ended December 31, 2007, 2008 and 2009:

 
  Year Ended December 31,   2008 vs. 2007   2009 vs. 2008  
 
  2007   2008   2009   $ Change   % Change   $ Change   % Change  
 
  (dollars in thousands)
 

Consumer Services

                                           
 

Access and service

  $ 897,423   $ 682,135   $ 503,769   $ (215,288 )   -24%   $ (178,366 )   -26%  
 

Value-added services

    127,985     97,741     71,643     (30,244 )   -24%     (26,098 )   -27%  
                                   
   

Total revenues

  $ 1,025,408   $ 779,876   $ 575,412   $ (245,532 )   -24%   $ (204,464 )   -26%  

Business Services

                                           
 

Access and service

  $ 187,709   $ 172,944   $ 146,087   $ (14,765 )   -8%   $ (26,857 )   -16%  
 

Value-added services

    2,877     2,757     2,230     (120 )   -4%     (527 )   -19%  
                                   
   

Total revenues

  $ 190,586   $ 175,701   $ 148,317   $ (14,885 )   -8%   $ (27,384 )   -16%  

Consolidated

                                           
 

Access and service

  $ 1,085,132   $ 855,079   $ 649,856   $ (230,053 )   -21%   $ (205,223 )   -24%  
 

Value-added services

    130,862     100,498     73,873     (30,364 )   -23%     (26,625 )   -26%  
                                   
   

Total revenues

  $ 1,215,994   $ 955,577   $ 723,729   $ (260,417 )   -21%   $ (231,848 )   -24%  
                                   

Consolidated revenues

        The primary component of our revenues is access and service revenues, which consist of narrowband access services (including traditional, fully-featured narrowband access and value-priced narrowband access); broadband access services (including high-speed access via DSL and cable; VoIP; and managed IP-based wide area networks); and web hosting services. We also earn revenues from value-added services, which include revenues from ancillary services sold as add-on features to our Internet access services, search and advertising. Total revenues were $1.2 billion, $1.0 billion and $0.7 billion during the years ended December 31, 2007, 2008 and 2009, respectively. The decreases over the past three years were primarily due to decreases in our Consumer Services segment, resulting from decreases in average consumer subscribers, which were approximately 4.3 million, 3.1 million and 2.3 million during the years ended December 31, 2007, 2008 and 2009, respectively. These decreases were driven by narrowband and broadband subscribers, as we reduced our sales and marketing efforts in connection with our refocused strategy and as the market for Internet access continued to mature. Also contributing to the decrease in total revenues were decreases in our Business Services segment. The decreases in business services revenue were primarily due to decreases in average business subscribers, which were approximately 207,000, 179,000 and 149,000 during the years ended December 31, 2007, 2008 and 2009, respectively. Slightly offsetting the decreases in our average business subscribers were increases in business services ARPU, which increased due to the shift in mix of our business access subscriber base from business dial-up and high-speed services to IP-based network services.

Consumer services revenues

        Access and service.     Consumer access and service revenues consist of narrowband access (including traditional, fully-featured narrowband access and value-priced narrowband access) and broadband access services (including high-speed access via DSL and cable and VoIP services). These revenues are derived from fees charged to customers for dial-up Internet access; fees charged for high-speed access services; fees charged for VoIP services; usage fees; shipping and handling fees; and termination fees.

        Consumer access and service revenues decreased $215.3 million, or 24%, from the year ended December 31, 2007 to the year ended December 31, 2008 and decreased $178.4 million, or 26%, from the

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year ended December 31, 2008 to the year ended December 31, 2009. The decreases in consumer access and service revenues were due to decreases in narrowband access and broadband access revenues. Narrowband access revenues decreased due to a decrease in average premium narrowband and value-priced narrowband subscribers resulting from reduced sales and marketing activities and the continued maturation of and competition in the market for narrowband Internet access. During 2008 and 2009, we significantly reduced sales and marketing efforts. We are focusing our efforts primarily on the retention of our customers and adding customers that have similar characteristics of our tenured customer base and are more likely to produce an acceptable rate of return. Average consumer narrowband subscribers were 3.0 million, 2.1 million and 1.5 million during the years ended December 31, 2007, 2008 and 2009. Our value-priced narrowband services comprised a larger proportion of this decrease, as average PeoplePC access subscribers was approximately 50%, 47% and 39% of our average consumer narrowband customer base during the years ended December 31, 2007, 2008 and 2009, respectively. Broadband access revenues decreased due to a decline in average broadband subscribers resulting from reduced sales and marketing efforts and competitive pressures. Average consumer broadband subscribers were 1.3 million, 0.9 million and 0.8 million during the years ended December 31, 2007, 2008 and 2009, respectively. Contributing to the decrease in broadband access revenues during the year ended December 31, 2008 compared to the prior year period was the removal of 753,000 Embarq subscribers effective April 2007.

        Offsetting the decline in average consumer subscribers was an improvement in consumer subscriber churn rates, which were 5.2%, 4.4% and 3.6% during the years ended December 31, 2007, 2008 and 2009, respectively. We expect our consumer access and service subscriber base to continue to decrease due to decreased sales and marketing activities, competitive pressures and the continued maturation of the market for narrowband Internet access. However, as our customers become more tenured, we expect our churn rates to decline.

        Value-added services revenues.     Value-added services revenues consist of revenues from ancillary services sold as add-on features to our Internet access services, such as security products, premium email only, home networking, email storage and Internet call waiting; search revenues; and advertising revenues. We derive these revenues from fees charged for ancillary services; paid placements for searches; delivering traffic to our partners in the form of subscribers, page views or e-commerce transactions; advertising our partners' products and services in our various online properties and electronic publications; and referring our customers to our partners' products and services.

        Value-added services revenues decreased $30.2 million, or 24%, from the year ended December 31, 2007 to the year ended December 31, 2008. This was due primarily to decreases in search advertising revenues and in partnership advertising revenues, which resulted from the decline in total average consumer subscribers, from 4.3 million during the year ended December 31, 2007 to 3.1 million during the year ended December 31, 2008. The decline in subscribers also caused sales of ancillary services to decrease.

        Value-added services revenues decreased $26.1 million, or 27%, from the year ended December 31, 2008 to the year ended December 31, 2009. This was due primarily to decreases in subscribers for ancillary services, primarily security services, and in search advertising revenues. The decreases resulted from the decline in total average consumer subscribers from 3.1 million during the year ended December 31, 2008 to 2.3 million during the year ended December 31, 2009. However, partially offsetting these decreases was an increase in subscription revenue per subscriber.

Business services revenues

        The primary component of business services revenues is access and service revenues, and includes New Edge access and service revenues. Business access and service revenues consist of fees charged for managed IP-based networks; fees charged for Internet access services; installation fees; termination fees; fees for equipment; usage fees; and cost recovery fees billed to customers. Business access and service

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revenues also consist of web hosting revenues from leasing server space and providing web services to enable customers to build and maintain an effective online presence. We sell our services to end-user business customers and to wholesale customers. Our end users range from large enterprises with many locations, to small and medium-sized multi-site businesses to business customers with one site, often a home-based location. Our wholesale customers consist primarily of telecommunications carriers. Many of our end user customers are retail businesses.

        Business access and service revenues decreased $14.8 million, or 8%, from the year ended December 31, 2007 to the year ended December 31, 2008. The decrease was primarily due to a decrease in average business access and service subscribers, comprised of decreases in average web hosting accounts, average New Edge customers and average business narrowband customers. Our wholesale business was also negatively impacted by consolidation in the telecommunications industry. In addition, our business customers are particularly exposed to a weak economy. Our churn rates for business services customers increased during the year ended December 31, 2008 as a result of our customers experiencing downsizing, retail store closures and other business issues resulting from the economic downturn.

        Business access and service revenues decreased $26.9 million, or 16%, from the year ended December 31, 2008 to the year ended December 31, 2009. The decrease was primarily due to a decrease in New Edge revenues resulting from a decrease in average subscribers and an increase in promotions and retention incentives necessary to attract and retain subscribers in a difficult economic environment. Although our churn rates decreased during the year ended December 31, 2009 compared to the prior period, the number of new customers we were able to add was negatively impacted by economic and competitive pressures. Also contributing to the decrease in business access and service revenues were decreases in average web hosting accounts, average business broadband customers and average business narrowband customers. Business access and service ARPU increased during the year ended December 31, 2009 compared to the prior period due to the shift in mix of our business access subscriber base from business dial-up and high-speed services to IP-based network services.

Cost of revenues

        Cost of revenues consist of telecommunications fees, set-up fees, the costs of equipment sold to customers for use with our services, depreciation of our network equipment and surcharges due to regulatory agencies. Our principal provider for narrowband services is Level 3 Communications, Inc. Our largest providers of broadband connectivity are AT&T Inc., Comcast Corporation, Covad Communications Group, Inc. ("Covad"), Qwest Corporation, Time Warner Cable and Verizon Communications, Inc. We also do lesser amounts of business with a wide variety of local, regional and other national providers. Cost of revenues also includes sales incentives. We offer sales incentives, such as free modems and Internet access on a trial basis, for certain products and promotions.

        Total cost of revenues decreased $81.8 million, or 18%, from the year ended December 31, 2007 to the year ended December 31, 2008. This decrease was comprised of a $64.6 million decrease in consumer services cost of revenues and $17.2 million decrease in business services cost of revenue. Consumer services cost of revenues decreased primarily due to the decline in average consumer services subscribers as a result of our refocused strategy. Also contributing to the decrease was a decline in sales incentives resulting from fewer gross subscriber additions during the year ended December 31, 2008, as we reduced our customer acquisition activities. Partially offsetting this decrease was an increase in average consumer cost of revenue per subscriber due to a greater proportion of our consumer subscriber base consisting of broadband subscribers. Business services cost of revenues decreased due to a decrease in average business services subscribers and a decrease in average monthly costs per subscriber, primarily as a result of a decrease in New Edge cost of revenues due to more favorable agreements with telecommunications service providers. Total cost of revenues increased from 36% of revenues to 38% of revenues due to a greater proportion of our subscriber base consisting of broadband subscribers.

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        Total cost of revenues decreased $87.2 million, or 24%, from the year ended December 31, 2008 to the year ended December 31, 2009. This decrease was comprised of a $73.3 million decrease in consumer services cost of revenues and $13.9 million decrease in business services cost of revenue. Consumer services cost of revenues decreased primarily due to the decline in average consumer services subscribers. Also contributing was a decline in average consumer cost of revenue per subscriber resulting from contract renegotiations with network service providers and internal network cost management efforts. Business services cost of revenues decreased due to a decrease in average business services subscribers. Total cost of revenues remained constant at 38% of revenues due to our contract renegotiations and internal network cost management efforts which mitigated the effect of the change in mix of our subscriber base to broadband subscribers.

Sales and marketing

        Sales and marketing expenses include advertising and promotion expenses, fees paid to distribution partners to acquire new paying subscribers and compensation and related costs (including stock-based compensation).

        Sales and marketing expenses decreased $192.9 million, or 66%, from the year ended December 31, 2007 to the year ended December 31, 2008. The decrease consisted primarily of a decrease in advertising and promotions expense, personnel-related costs and outsourced labor resulting from the change in our business strategy to significantly reduce discretionary sales and marketing spend and benefits from the 2007 Plan. Sales and marketing expenses decreased from 24% of revenues during the year ended December 31, 2007 to 10% of revenues during year ended December 31, 2008, as we reduced sales and marketing efforts that resulted in adding customers that did not provide an acceptable rate of return or that had a pattern of early life churn.

        Sales and marketing expenses decreased $38.7 million, or 39%, from the year ended December 31, 2008 to the year ended December 31, 2009. The decrease consisted primarily of decreases in advertising and promotions expense, personnel-related costs, outsourced labor and occupancy and related costs resulting from reduced headcount and continued cost reduction initiatives. Sales and marketing expenses decreased from 10% of revenues during the year ended December 31, 2008 to 8% of revenues during year ended December 31, 2009, as we continued to reduce sales and marketing efforts and focused our efforts primarily on the retention of customers and on marketing channels that are more likely to produce an acceptable rate of return.

Operations and customer support

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

        Operations and customer support expenses decreased $84.6 million, or 38%, from the year ended December 31, 2007 to the year ended December 31, 2008. The decrease in operations and customer support expenses consisted of decreases in personnel-related costs, outsourced labor, professional fees and occupancy costs. These decreases were primarily attributable to benefits realized as a result of the 2007 Plan and a decrease in call volumes for customer service and technical support as our overall subscriber base has decreased and become longer tenured. Our longer tenured customers require less customer service and technical support. Operations and customer support expenses decreased from 18% of revenues the year ended December 31, 2007 to 14% of revenues during the year ended December 31, 2008.

        Operations and customer support expenses decreased $38.4 million, or 28%, from the year ended December 31, 2008 to the year ended December 31, 2009. The decrease in operations and customer support expenses consisted of decreases in personnel-related costs, outsourced labor and occupancy and related costs. These decreases were primarily attributable to our efforts to reduce our back-office cost

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structure, including reduced headcount and continued cost reduction initiatives, and a decrease in call volumes for customer service and technical support as our overall subscriber base has decreased and become longer tenured. In addition, we consolidated to primarily one outsourced customer service and technical support provider for our consumer services, which resulted in cost benefits. Operations and customer support expenses remained constant as a percent of revenues at 14% during the years ended December 31, 2008 and 2009.

General and administrative

        General and administrative expenses consist of compensation and related costs (including stock-based compensation) associated with our finance, legal, facilities and human resources organizations; fees for professional services; payment processing; credit card fees; collections and bad debt.

        General and administrative expenses decreased $34.5 million, or 27%, from the year ended December 31, 2007 to the year ended December 31, 2008. The decrease in general and administrative expenses consisted primarily of decreases in bad debt and payment processing fees, personnel-related costs, professional and legal fees, and stock-based compensation expense. Bad debt and payment processing fees decreased due to the decrease in our overall subscriber base and due to our subscriber base consisting of longer tenured customers, who have a lower frequency of non-payment. The decrease in personnel-related costs, professional and legal fees was attributable to our efforts to reduce our back-office cost structure, including benefits realized as a result of the 2007 Plan. General and administrative expenses decreased from 11% of revenues the year ended December 31, 2007 to 10% of revenues during the year ended December 31, 2008.

        General and administrative expenses decreased $21.5 million, or 23%, from the year ended December 31, 2008 to the year ended December 31, 2009. The decreases in general and administrative expenses consisted primarily of decreases in bad debt and payment processing fees, personnel-related costs and legal and professional fees. Bad debt and payment processing fees decreased due to the decrease in our overall subscriber base and due to our subscriber base consisting of longer tenured customers, who have a lower frequency of non-payment. The decrease in personnel-related costs and professional and legal fees was attributable to reduced headcount and continued cost reduction initiatives. Partially offsetting these decreases were costs incurred as a result of certain legal settlements and resolution of various state and local tax issues and audits. As a result of the items noted above, general and administrative expenses remained constant as a percent of revenues at 10% during the years ended December 31, 2008 and 2009.

Amortization of intangible assets

        Amortization of intangible assets represents the amortization of definite-lived intangible assets acquired in purchases of businesses and purchases of customer bases from other companies. Definite-lived intangible assets, which primarily consist of subscriber bases and customer relationships, acquired software and technology, trade names and other assets, are amortized on a straight-line basis over their estimated useful lives, which range from three to six years. Amortization of intangible assets decreased $1.3 million, or 9%, from the year ended December 31, 2007 to the year ended December 31, 2008. The decrease in amortization of intangible assets compared to the prior year period was primarily due to certain identifiable definite-lived intangible assets becoming fully amortized over the past year. Amortization of intangible assets decreased $5.6 million, or 42%, from the year ended December 31, 2008 to the year ended December 31, 2009. The decrease in amortization of intangible assets compared to the prior year period was primarily due to certain identifiable definite-lived intangible assets becoming fully amortized over the past year. In addition, we impaired certain identifiable definite-lived intangible assets during the fourth quarter of 2008, which contributed to the decrease in amortization expense.

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Impairment of goodwill and intangible assets

        During the years ended December 31, 2007, 2008 and 2009, we recorded non-cash impairment charges for goodwill and intangible assets of $4.3 million, $78.7 million and $24.1 million, respectively. We test goodwill and indefinite-lived intangible assets for impairment annually or when events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable.

        After completing our annual impairment test during the fourth quarter of 2008, we concluded that goodwill and certain intangible assets recorded as a result of our April 2006 acquisition of New Edge were impaired and we recorded non-cash impairment charges related to the New Edge reporting unit of $64.0 million for goodwill, $3.1 million for the indefinite-lived trade name and $11.6 million for customer relationships. The primary factor contributing to the impairment charge was the recent significant economic downturn. New Edge serves a large percentage of small and medium-sized business customers, especially retail businesses, which have been particularly affected by the recent economic downturn. Economic conditions affecting retail businesses worsened substantially during the "holiday season" in the fourth quarter of 2008. As a result, management updated its long-range financial outlook, which reflected decreased expectations of future growth rates and cash flows for New Edge. We used this updated financial outlook in conjunction with our annual impairment test.

        After completing our annual impairment test during the fourth quarter of 2009, we concluded that goodwill and certain intangible assets recorded as a result of the New Edge acquisition were further impaired and recorded non-cash impairment charges related to the New Edge reporting unit of $23.9 million for goodwill and $0.2 million for the indefinite-lived trade name. As a result, there is no remaining carrying value related to New Edge goodwill. The primary factor contributing to the impairment charge was continued sales pressure in the small and medium-sized business market due to the economy, which adversely impacted our long-range financial outlook.

        Goodwill.     Impairment testing of goodwill is required at the reporting unit level and involves a two-step process. Although we operate two reportable segments, Consumer Services and Business Services, we have identified three reporting units for evaluating goodwill, which are Consumer Services, New Edge and Web Hosting. The Consumer Services reportable segment is one reporting unit, while the Business Services reportable segment consists of two reporting units, New Edge and Web Hosting. Each of these reporting units constitutes a business for which discrete financial information is available and segment management regularly reviews the operating results.

        The first step of the impairment test involves comparing the estimated fair value of our reporting units with the reporting unit's carrying amount, including goodwill. We estimated the fair values of our reporting units primarily using the income approach valuation methodology that included the discounted cash flow method, taking into consideration the market approach and certain market multiples as a validation of the values derived using the discounted cash flow methodology. The discounted cash flows for each reporting unit were based on discrete financial forecasts developed by management for planning purposes. Cash flows beyond the discrete forecasts were estimated by using a terminal value calculation, which incorporated historical and forecasted financial trends for each identified reporting unit.

        Upon completion of the first step of the impairment test during the years ended December 31, 2008 and 2009, we determined that the carrying value of our New Edge reporting unit exceeded its estimated fair value. Because indicators of impairment existed for this reporting unit, we performed the second step of the test. We determined the implied fair value of goodwill in the same manner used to recognize goodwill in a business combination. To determine the implied value of goodwill, we allocated fair values to the assets and liabilities of the New Edge reporting unit. We calculated the implied fair value of goodwill as the excess of the fair value of the New Edge reporting unit over the amounts assigned to its assets and liabilities. We determined the $64.0 million and $23.9 million impairment losses during the years ended December 31, 2008 and 2009, respectively, as the amount by which the carrying value of goodwill exceeded the implied fair value of the goodwill.

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        Indefinite-lived intangible assets.     The impairment test for our indefinite-lived intangible assets, which consist of trade names, involves a comparison of the estimated fair value of the intangible asset with its carrying value. We determined the fair value of our trade names using the royalty savings method, in which the fair value of the asset was calculated based on the present value of the royalty stream that we are saving by owning the asset. Given the economic environment and other factors noted above, we decreased our estimates for revenues associated with our New Edge trade name. As a result, we recorded non-cash impairment charges related to our New Edge trade name of $3.1 million and $0.2 million during the years ended December 31, 2008 and 2009, respectively. We also recorded a non-cash impairment charge of $4.3 million during the year ended December 31, 2007 related to the analysis of our other indefinite-lived trade names.

        Definite-lived intangible assets.     As a result of the goodwill and indefinite-lived asset impairments in the New Edge reporting unit, we also tested this segment's definite-lived intangible assets for impairment. Because of the decrease in expected future cash from such definite-lived intangible assets, we concluded certain customer relationships were not fully recoverable and recorded a non-cash impairment charge of $11.6 million during the year ended December 31, 2008. We did not record any impairment charges for our definite-lived intangible assets during the years ended December 31, 2007 and 2009.

Facility exit and restructuring costs

        Facility exit and restructuring costs consisted of the following during the years ended December 31, 2007, 2008 and 2009:

 
  Year Ended December 31,  
 
  2007   2008   2009  
 
  (in thousands)
 

2007 Restructuring Plan

                   
 

Severance and personnel-related costs

  $ 30,303   $ 461   $  
 

Lease termination and facilities-related costs

    12,216     4,808     5,697  
 

Non-cash asset impairments

    20,621     4,125     46  
 

Other associated costs

    1,131          
               

    64,271     9,394     5,743  

Legacy Restructuring Plans

    1,110     (252 )   (128 )
               
 

Total facility exit and restucturing costs

  $ 65,381   $ 9,142   $ 5,615  
               

        2007 Restructuring Plan.     In August 2007, we adopted a restructuring plan to reduce costs and improve the efficiency of our operations. The 2007 Plan was the result of a comprehensive review of operations within and across our functions and businesses. Under the 2007 Plan, we reduced our workforce by approximately 900 employees, consolidated our office facilities in Atlanta, Georgia and Pasadena, California and closed office facilities in Orlando, Florida; Knoxville, Tennessee; Harrisburg, Pennsylvania and San Francisco, California. The 2007 Plan was primarily implemented during the latter half of 2007 and during 2008. As a result of the 2007 Plan, we recorded facility exit and restructuring costs of $64.3 million, $9.4 million and $5.7 million during the years ended December 31, 2007, 2008 and 2009, respectively. The asset impairment charges primarily relate to fixed asset write-offs due to facility closings and consolidations and the termination of certain projects for which costs had been capitalized. These assets were impaired as the carrying values of the assets exceeded the expected future undiscounted cash flows to us. Since management continues to evaluate EarthLink's businesses, there have been and may continue to be supplemental provisions for new plan initiatives as well as changes in estimates to amounts previously recorded.

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        Legacy Restructuring Plans.     During the years ended December 31, 2003, 2004 and 2005, we executed a series of plans to restructure and streamline our contact center operations and outsource certain internal functions (collectively referred to as "Legacy Plans"). The Legacy Plans included facility exit costs, personnel-related costs and asset disposals. We periodically evaluate and adjust our estimates for facility exit and restructuring costs based on currently-available information and record such adjustments as facility exit and restructuring costs. During the year ended December 31, 2007, we recorded $1.1 million of facility exit and restructuring costs as a result of changes in estimates for Legacy Plans. During the years ended December 31, 2008 and 2009, we recorded reductions of $0.3 million and $0.1 million, respectively, to facility exit and restructuring costs as a result of changes in estimates for Legacy Plans.

Net losses of equity affiliate

        We had a joint venture with SK Telecom Co., Ltd., HELIO. HELIO was a non-facilities-based mobile virtual network operator offering mobile communications services and handsets to consumers in the U.S. We accounted for our investment in HELIO under the equity method of accounting because we were able to exert significant influence over HELIO's operating and financial policies. Accordingly, we recorded our proportionate share of HELIO's net losses. These equity method losses were offset by increases in the carrying value of our investment associated with amortizing the difference between the carrying value and fair value of non-cash assets contributed to HELIO.

        Net losses of equity affiliate for the year ended December 31, 2007 of $111.3 million included our proportionate share of HELIO's net losses offset by amortization associated with recognizing the difference between the carrying value and fair value of non-cash assets contributed. During the year ended December 31, 2007, we stopped recording additional net losses of equity affiliate because the carrying value of our investment in HELIO was reduced to zero. In August 2008, Virgin Mobile USA, Inc. ("Virgin Mobile") acquired HELIO and our investment in HELIO was exchanged for limited partnership units equivalent to approximately 1.8 million shares of Virgin Mobile common stock. In November 2009, Sprint Nextel and Virgin Mobile completed a merger and we received 2.4 million shares of Sprint Nextel common stock for our Virgin Mobile common stock. As a result, we no longer have an investment in HELIO and we did not record any net losses of equity affiliate during the years ended December 31, 2008 and 2009.

Gain (loss) on investments, net

        Gain (loss) on investments, net, consisted of the following during the years ended December 31, 2007, 2008 and 2009:

 
  Year Ended December 31,  
 
  2007   2008   2009  
 
  (in thousands)
 

Other-than-temporary impairment losses

  $ (7,142 ) $ (3,556 ) $ (9,300 )

Cash distributions from investments

    1,557         231  

Gain from sale of Covad common stock

        2,025      

Gain from receipt of Virgin Mobile shares

        4,352      

Gain from receipt and sale of Sprint Nextel shares

            7,641  

Net change in fair value of auction rate securities and put right

        (113 )   107  
               

  $ (5,585 ) $ 2,708   $ (1,321 )
               

        We had an investment in Covad consisting of 6.1 million shares of Covad common stock and $47.5 million aggregate principal amount of 12% Senior Secured Convertible Notes due 2011. During the year ended December 31, 2008, Platinum Equity, LLC acquired all outstanding shares of Covad. As a result, we received cash of $6.3 million for our 6.1 million shares of Covad common stock and recognized a gain of $2.0 million based on our cost basis of the Covad common stock.

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        During the year ended December 31, 2008, we received limited partnership units equivalent to approximately 1.8 million shares of Virgin Mobile common stock in exchange for our investment in HELIO. We recognized a gain of $4.4 million as a result of this transaction. During the year ended December 31, 2009, Sprint Nextel and Virgin Mobile completed a merger and we received 2.4 million shares of Sprint Nextel common stock for our Virgin Mobile common stock. During the year ended December 31, 2009, we sold 2.2 million of the Sprint Nextel shares for net proceeds of $8.2 million. We recorded a $7.6 million gain resulting from the receipt of Sprint Nextel shares and the subsequent sale.

        As of December 31, 2008 and 2009, we held auction rate securities with a carrying value and fair value of $47.8 million and $42.9 million, respectively. These securities are variable-rate debt instruments whose underlying agreements have contractual maturities of up to 40 years, but have interest rate reset periods at pre-determined intervals, usually every 28 days. These securities are predominantly secured by student loans guaranteed by state related higher education agencies and reinsured by the U.S. Department of Education. Beginning in February 2008, auctions for these securities failed to attract sufficient buyers, resulting in us continuing to hold such securities. In October 2008, we entered into an agreement with the broker that sold us our auction rate securities that gives us the right to sell our existing auction rate securities back to the broker at par plus accrued interest, beginning on June 30, 2010 until July 2, 2012 (herein referred to as "put right"). During 2008, we recorded an other-than-temporary impairment of $9.9 million to reflect the auction rate securities at their fair value, as we no longer had the intent to hold the securities until maturity. We also elected a one-time transfer of our auction rate securities from the available-for-sale category to the trading category. We recorded the value of the put right in our Consolidated Balance Sheet with a corresponding $9.8 million gain on investments in the Consolidated Statement of Operations. We elected the fair value option for the put right to offset the fair value changes of the auction rate securities. The other-than-temporary impairment, net of the gain on the put right, was $0.1 million during the year ended December 31, 2008. During the year ended December 31, 2009, we redeemed $9.6 million of auction rate securities at par and recognized a net gain of $0.1 million resulting from the redemption and net changes in fair value of our auction rate securities and put right.

Interest income (expense) and other, net

        Interest income (expense) and other, net, is primarily comprised of interest expense incurred on our Convertible Senior Notes due November 15, 2026 ("Notes"); interest earned on our cash, cash equivalents and marketable securities; and other miscellaneous income and expense items. We recognized net interest income of $2.8 million during the year ended December 31, 2007 compared to net interest expense of $12.4 million during the year ended December 31, 2008. This was primarily due to a decrease in interest earned on our cash, cash equivalents and marketable securities, despite an increase in our average cash and marketable securities balance, due to lower investment yields from deteriorating financial and credit markets. Also contributing to the decrease was the liquidation of our Covad debt investment, which was repurchased by Platinum Equity, LLC in April 2008.

        Interest expense and other, net, increased $7.4 million, from $12.4 million during the year ended December 31, 2008 to $19.8 million during the year ended December 31, 2009. The increase was primarily due to a decrease in interest earned on our cash, cash equivalents and marketable securities, despite an increase in our average cash and marketable securities balance, due to lower investment yields from deteriorating financial and credit markets. Also contributing to the increase was an increase in interest expense resulting from an increase in accretion of the debt discount relating to our Notes.

Income tax (provision) benefit

        We recognized an income tax benefit of $1.2 million during year ended December 31, 2007, which was primarily due to the change in the deferred tax liability related to long-lived assets. We recognized an income tax benefit of $32.2 million during year ended December 31, 2008. This consisted primarily of a benefit of $56.1 million resulting from the release of a portion of our valuation allowance against our

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deferred tax assets, primarily related to net operating loss carryforwards. Offsetting this benefit was an income tax provision of $23.9 million recorded during the year ended December 31, 2008. The tax provision consisted of $7.0 million state income and federal and state alternative minimum tax ("AMT") amounts payable due to the net operating loss carryforward limitations associated with the AMT calculation and $16.9 million for non-cash deferred tax provisions associated with the utilization of net operating loss carryforwards which were acquired in connection with acquisitions. We recognized an income tax benefit of $126.1 million during year ended December 31, 2009. This benefit consisted primarily of a benefit of $198.8 million resulting from the release of a portion of our valuation allowance against our deferred tax assets, primarily related to net operating loss carryforwards. During the year ended December 31, 2009, we determined we will more likely than not be able to utilize these deferred tax assets due to the generation of sufficient taxable income in the immediate future. Offsetting this benefit was an income tax provision of $72.6 million, consisting of $9.3 million state income and federal and state AMT amounts payable and $63.3 million for non-cash deferred tax provisions associated with the utilization of net operating loss carryforwards.

        We continue to maintain a valuation allowance of $34.1 million against our unrealized deferred tax assets, which include net operating loss carryforwards. Of this amount, $31.7 million relates to net operating losses generated by the tax benefits of certain stock compensation arrangements. The valuation allowance will be removed upon utilization of these net operating losses as an adjustment to additional paid-in-capital. The remaining $2.4 million valuation allowance is retained for net operating losses in certain jurisdictions where there is uncertainty regarding realization.

        To the extent we report income in future periods, we intend to use our net operating loss carryforwards to the extent available to offset taxable income and reduce cash outflows for income taxes. Our ability to use our federal and state net operating loss carryforwards and federal and state tax credit carryforwards may be subject to restrictions attributable to equity transactions in the future resulting from changes in ownership as defined under the Internal Revenue Code.

Loss from discontinued operations, net of tax

        Loss from discontinued operations, net of tax, during the years ended December 31, 2007 and 2008 reflects our municipal wireless broadband operations. In November 2007, management concluded that our municipal wireless broadband operations were no longer consistent with our strategic direction and our Board of Directors authorized management to pursue the divestiture of our municipal wireless broadband assets. The municipal wireless results of operations were previously included in our Consumer Services segment.

        During the year ended December 31, 2008, we transferred our municipal wireless broadband networks to Corpus Christi, TX and Milpitas, CA in exchange for releasing us from our existing network agreements. We also transferred our municipal wireless broadband networks in the city of Philadelphia, PA to a local Philadelphia company. Additionally, we terminated our municipal wireless broadband service in New Orleans, LA and Anaheim, CA and removed our network equipment from those cities. As of December 31, 2008, the divestiture of our municipal wireless broadband assets was complete.

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        The following table presents summarized results of operations related to our discontinued operations for the years ended December 31, 2007 and 2008:

 
  Year Ended December 31,  
 
  2007   2008  
 
  (in thousands)
 

Revenues

  $ 2,097   $ 1,305  

Operating costs and expenses

    (33,871 )   (4,569 )

Impairment, facility exit and restructuring costs

    (48,528 )   (6,326 )

Income tax benefit

        1,084  
           

Loss from discontinued operations, net of tax

  $ (80,302 ) $ (8,506 )
           

        Loss from discontinued operations, net of tax, decreased $71.8 million from the year ended December 31, 2007 to the year ended December 31, 2008. This was primarily due to a decrease in impairment and facility exit and restructuring costs, as well as a decrease in operating costs and expenses as we discontinued our municipal wireless broadband operations during 2008.

Stock-Based Compensation

        We measure stock-based compensation cost for all stock awards at fair value on the date of grant and recognition of compensation over the requisite service period for awards expected to vest. The fair value of our stock options is estimated using the Black-Scholes valuation model, and the fair value of restricted stock units is determined based on the number of shares granted and the quoted price of our common stock on the date of grant. Such value is recognized as expense over the requisite service period, net of estimated forfeitures, using the straight-line attribution method. For performance-based awards, we recognize expense over the requisite service period, net of estimated forfeitures, using the accelerated attribution method when it is probable that the performance measure will be achieved. The estimate of awards that will ultimately vest requires significant judgment, and to the extent actual results or updated estimates differ from management's current estimates, such amounts will be recorded as a cumulative adjustment in the period estimates are revised. We consider many factors when estimating expected forfeitures, including types of awards, employee class and historical employee attrition rates. Actual results, and future changes in estimates, may differ substantially from our current estimates.

        Stock-based compensation expense was $19.6 million, $20.1 million and $13.2 million during the years ended December 31, 2007, 2008 and 2009, respectively. Stock-based compensation expense is classified within the same operating expense line items as cash compensation paid to employees. Stock-based compensation was allocated as follows for the years ended December 31, 2007, 2008 and 2009:

 
  Year Ended December 31,  
 
  2007   2008   2009  
 
  (in thousands)
 

Sales and marketing

  $ 3,826   $ 5,713   $ 3,633  

Operations and customer support

    7,007     9,829     6,544  

General and administrative

    8,720     4,591     3,054  
               

  $ 19,553   $ 20,133   $ 13,231  
               

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Facility Exit and Restructuring Costs

        2007 Plan.     We expect to incur future cash outflows for real estate obligations through 2014 related to the 2007 Plan. The following table summarizes activity for the liability balances associated with the 2007 Plan for the years ended December 31, 2007, 2008 and 2009, including changes during the year attributable to costs incurred and charged to expense and costs paid or otherwise settled:

 
  Severance
and Benefits
  Facilities   Asset
Impairments
  Other
Costs
  Total  
 
  (in thousands)
 

Balance as of December 31, 2006

  $   $   $   $   $  
 

Accruals

    30,303     12,216     20,621     1,131     64,271  
 

Payments

    (18,262 )   (480 )       (760 )   (19,502 )
 

Non-cash charges

        4,388     (20,621 )   (371 )   (16,604 )
                       

Balance as of December 31, 2007

    12,041     16,124             28,165  
 

Accruals

    461     4,808     4,125         9,394  
 

Payments

    (12,502 )   (6,174 )           (18,676 )
 

Non-cash charges

        1,936     (4,125 )       (2,189 )
                       

Balance as of December 31, 2008

        16,694             16,694  
 

Accruals

        5,697     46         5,743  
 

Payments

        (5,442 )           (5,442 )
 

Non-cash charges

        489     (46 )       443  
                       

Balance as of December 31, 2009

  $   $ 17,438   $   $   $ 17,438  
                       

        Legacy Plans.     As of December 31, 2009, we had a $0.5 million liability remaining for real estate commitments associated with the Legacy Plans. All other costs have been paid or otherwise settled. We expect to incur future cash outflows for real estate obligations through 2010 related to the Legacy Plans.

Liquidity and Capital Resources

        The following table sets forth summarized cash flow data for the years ended December 31, 2007, 2008 and 2009:

 
  Year Ended December 31,  
 
  2007   2008   2009  
 
  (in thousands)
 

Net income (loss)

  $ (145,097 ) $ 178,584   $ 287,118  

Non-cash items

    265,252     112,307     (58,711 )

Changes in working capital

    (31,366 )   (60,279 )   (19,785 )
               

Net cash provided by operating activities

  $ 88,789   $ 230,612   $ 208,622  
               

Net cash provided by (used in) investing activities

  $ 13,936   $ 107,124   $ (37,121 )
               

Net cash used in financing activities

  $ (87,267 ) $ (24,999 ) $ (47,070 )
               

Operating activities

        Net cash provided by operating activities increased during the year ended December 31, 2008 compared to the year ended December 31, 2007. The increase was primarily due to a decrease in costs to acquire and support new customers, a decrease in operating costs resulting from our efforts to reduce our back-office cost structure, benefits realized from the 2007 Plan and a reduction in customer support costs and bad debt expense as our overall subscriber base has decreased and become longer tenured. Net cash provided by operating activities decreased during the year ended December 31, 2009 compared to the year

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ended December 31, 2008 primarily due to a decrease in revenues as our overall subscriber base has decreased over the past year. However, this decrease was partially offset by reduced sales and marketing spending, reduced telecommunication costs, reduced back-office support costs and reduced customer support and bad debt expense as our overall subscriber base has decreased and become longer tenured.

        Non-cash items include items that are not expected to generate or require the use of cash, such as depreciation and amortization relating to our network, facilities and intangible assets, net losses of equity affiliate, deferred income taxes, stock-based compensation, non-cash disposals and impairments of fixed assets, impairments of goodwill and intangible assets, gain (loss) on investments, net, accretion of debt discount and amortization of debt issuance costs. Non-cash items decreased during the year ended December 31, 2008 compared to the prior year primarily due to a decrease in net losses of equity affiliate and an increase in non-cash income tax benefits, offset by an increase in impairment of goodwill and intangible assets. Non-cash items decreased during the year ended December 31, 2009 compared to the prior year period due to an increase in deferred income taxes, which was partially offset by decreases in depreciation expense and loss on disposals and impairments of fixed assets.

        Changes in working capital requirements include changes in accounts receivable, prepaid and other assets, accounts payable, accrued and other liabilities and deferred revenue. Cash used for working capital requirements increased during 2008 compared to the prior year primarily due to payments resulting from the 2007 Plan and from the discontinuation of our municipal wireless broadband operations. Cash used for working capital requirements decreased during the year ended December 31, 2009 compared to the prior year period primarily due to reduced back office support and sales and marketing spending. Also contributing to the decrease were decreases in payments resulting from the 2007 Plan, from other workforce reductions and from the discontinuation of our municipal wireless broadband operations.

Investing activities

        Our investing activities provided cash of $13.9 million during the year ended December 31, 2007. This consisted primarily of $122.0 million of sales and maturities of investments in marketable securities, net of purchases, and $1.6 million of distributions received from investments in other companies. These were partially offset by $53.5 million of capital expenditures, $30.0 million loaned to HELIO, $19.5 million of contributions to HELIO and $7.3 million to purchase subscriber bases from other ISPs.

        Our investing activities provided cash of $107.1 million during the year ended December 31, 2008. This consisted primarily of $57.1 million received for our Covad investment and $56.9 million of sales and maturities of investments in marketable securities, net of purchases. In April 2008, Platinum Equity, LLC acquired all outstanding shares of Covad. As a result, we received cash of $50.8 million for the aggregate principal amount of the 12% Senior Secured Convertible Notes due 2011 held by us plus accrued interest in April 2008 and we received cash of $6.3 million for our 6.1 million shares of Covad common stock in May 2008. The decreases were offset by $5.7 million of capital expenditures and $1.2 million used to purchase subscriber bases from other ISPs.

        Our investing activities used cash of $37.1 million during the year ended December 31, 2009. This consisted primarily of $32.4 million of purchases of investments in marketable securities, net of sales and maturities, and $13.1 million of capital expenditures, primarily associated with network and technology center related projects. This was offset by $8.4 million of proceeds received from investments in other companies. During the year ended December 31, 2009, we sold 2.2 million of our Sprint Nextel shares for net proceeds of $8.2 million and received $0.2 million in cash distributions from one of our investments.

Financing activities

        Our financing activities used cash of $87.3 million during the year ended December 31, 2007. This consisted primarily of $94.3 million used to repurchase 14.0 million shares of our common stock and $2.0 million used to repay a note payable. Partially offsetting cash used for repurchases were proceeds from

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the exercise of stock options of $9.5 million. Our financing activities used cash of $25.0 million during the year ended December 31, 2008. This consisted primarily of $31.9 million used to repurchase 3.8 million shares of our common stock and $2.7 million to pay off a capital lease obligation. Included in the share repurchase amount is the repurchase of approximately 2.5 million shares of common stock for approximately $22.7 million in connection with the termination of our convertible note hedge and warrant agreements. Partially offsetting cash used for repurchases were proceeds of $8.1 million from the exercise of stock options. Our financing activities used cash of $47.1 million during year ended December 31, 2009. This consisted primarily of $30.0 million for payment of dividends and $22.3 million used to repurchase 3.6 million shares of our common stock, offset by $5.3 million of proceeds from the exercise of stock options.

Future Uses of Cash and Funding Sources

        Uses of cash.     We expect to incur capital expenditures to maintain and upgrade our network and technology infrastructure. The actual amount of capital expenditures may fluctuate due to a number of factors which are difficult to predict and could change significantly over time. Additionally, technological advances may require us to make capital expenditures to develop or acquire new equipment or technology in order to replace aging or technologically obsolete equipment. We also expect to use cash to pay dividends on our common stock and restricted stock units. In 2009, we began paying quarterly cash dividends on our common stock. We currently intend to pay regular quarterly dividends on our common stock. Any decision to declare future dividends will be made at the discretion of the Board of Directors and will depend on, among other things, our results of operations, financial condition, cash requirements, investment opportunities and other factors the Board of Directors may deem relevant. We expect to continue to use cash to retain existing and acquire new subscribers for our services, which may include purchases of subscriber bases from other ISPs. We will also use cash to pay real estate obligations associated with facilities exited in our restructuring plans and for workforce reduction initiatives or other cost reduction initiatives. Finally, we may also use cash to invest in or acquire other companies, to pay additional dividends, to repurchase common stock, to repurchase Notes or in connection with holders' conversion of Notes. Although we continue to consider and evaluate potential investments or acquisitions, there can be no assurance that we will be able to consummate any such transaction.

        Our cash requirements depend on numerous factors, including our ability to maintain our customer base, the costs required to maintain our network infrastructure, the size and types of acquisitions in which we may engage, the pricing of our access services, and the level of resources used for our sales and marketing activities, among others.

        Sources of cash.     Our principal sources of liquidity are our cash, cash equivalents and investments in marketable securities, as well as the cash flow we generate from our operations. During the years ended December 31, 2007, 2008 and 2009, we generated $88.8 million, $230.6 million and $208.6 million in cash from operations, respectively. As of December 31, 2009, we had $611.0 million in cash and cash equivalents. In addition, we held short-term marketable securities valued at $85.0 million. Short-term marketable securities consist of investments that have effective maturity dates of up to one year from the balance sheet date. Our cash, cash equivalents and marketable securities are subject to general credit, liquidity, market, and interest rate risks, which may be exacerbated by unfavorable economic conditions. If financial markets experience prolonged periods of decline, the value or liquidity of our cash, cash equivalents and marketable securities could decline and result in an other-than-temporary decline in fair value, which could adversely affect our financial condition.

        Our short-term marketable securities as of December 31, 2009 included $42.9 million of auction rate securities. These securities are variable-rate debt instruments whose underlying agreements have contractual maturities of up to 40 years. The securities are issued by various state related higher education agencies and predominantly secured by student loans guaranteed by the agencies and reinsured by the United States Department of Education. Liquidity for these auction rate securities is typically provided by

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an auction process that resets the applicable interest rate at pre-determined intervals, usually every 28 days. Beginning in February 2008, all of our auction rate securities failed to attract sufficient buyers, resulting in our continuing to hold such securities. In October 2008, we entered into an agreement with the broker that sold us our auction rate securities that gives us the right to sell our existing auction rate securities back to the broker at par plus accrued interest, beginning on June 30, 2010 until July 2, 2012. The agreement also grants the broker the right to buy our auction rate securities at par plus accrued interest, until July 2, 2012. Based on our remaining cash and marketable securities and operating cash flows, we do not anticipate the current lack of liquidity on these investments will affect our ability to operate our business as usual.

        We expect to generate positive cash flows from operations during the year ended December 31, 2010. Our available cash and marketable securities, together with our results of operations, are expected to be sufficient to meet our operating expenses, capital requirements and investment and other obligations for the next 12 months. However, as a result of other investment activities, possible acquisition opportunities or other strategic uses of cash, we may seek additional financing in the future. We have no commitments for any additional financing and have no lines of credit or similar sources of financing. We cannot be sure that we can obtain additional financing on favorable terms, if at all, through the issuance of equity securities or the incurrence of additional debt. Additional equity financing may dilute our stockholders, and debt financing, if available, may restrict our ability to repurchase common stock or debt, declare and pay dividends and raise future capital. If we are unable to obtain additional needed financing, it may prohibit us from making acquisitions, capital expenditures and/or investments, which could materially and adversely affect our business.

Off-Balance Sheet Arrangements

        As of December 31, 2009, we did not have any off-balance sheet arrangements that have or are reasonably likely to have a current or future effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources that are material to investors.

Contractual Obligations and Commitments

        As of December 31, 2009, we had the following contractual commitments:

 
  Year Ending December 31,  
 
  2010   2011   2012   2013-
2014
 
 
  (in millions)
 

Operating leases (1)

  $ 12.5   $ 10.7   $ 10.1   $ 17.5  

Purchase commitments (2)

    0.5              

Convertible senior notes (3)

        258.8          
                   

  $ 13.0   $ 269.5   $ 10.1   $ 17.5  
                   

(1)
These amounts represent base rent payments under noncancellable operating leases for facilities and equipment that expire in various years through 2014, as well as an allocation for operating expenses. Not included in these amounts is expected sublease income of $2.5 million, $1.3 million, $1.3 million and $2.1 million during the years ended December 31, 2010, 2011, 2012 and thereafter, respectively.

(2)
We have commitments to purchase telecommunications services from one of our third party providers under a non-cancelable agreement.

(3)
During November 2006, we issued $258.8 million aggregate principal amount of Notes in a registered offering. The Notes are convertible on October 15, 2011 and upon certain events. We have the option to redeem the Notes, in whole or in part, for cash, on or after November 15, 2011, provided that we have made at least ten semi-annual interest payments. In addition, the holders may require us to purchase all or a portion of their Notes on each of November 15, 2011, November 15, 2016 and November 15, 2021.

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Share Repurchase Program

        The Board of Directors has authorized a total of $750.0 million to repurchase our common stock under our share repurchase program. As of December 31, 2009, we had utilized approximately $603.2 million pursuant to the authorizations and had $146.8 million available under the current authorization. We may repurchase our common stock from time to time in compliance with the Securities and Exchange Commission's regulations and other legal requirements, and subject to market conditions and other factors. The share repurchase program does not require us to acquire any specific number of shares and may be terminated by the Board of Directors at any time.

Income Taxes

        We continue to maintain a partial valuation allowance of $34.1 million against our net deferred tax assets, consisting primarily of net operating loss carryforwards. Of this amount, $31.7 million relates to net operating losses generated by the tax benefits of certain stock compensation arrangements. The valuation allowance will be removed upon utilization of these net operating losses as an adjustment to additional paid-in-capital. The remaining $2.4 million valuation allowance is retained for net operating losses in certain jurisdictions where there is uncertainty regarding realization.

        To the extent we owe income taxes in future periods, we intend to use our net operating loss carryforwards to the extent available to reduce cash outflows for income taxes. However, our ability to use our net operating loss carryforwards to offset future taxable income and future taxes, may be subject to restrictions attributable to equity transactions that result in changes in ownership as defined by Internal Revenue Code Section 382.

Related Party Transactions

        As a result of our prior ownership interest in HELIO, HELIO was considered a related party. In August 2008, Virgin Mobile acquired HELIO and our equity and debt investments in HELIO were exchanged for limited partnership units of Virgin Mobile. EarthLink and HELIO had a services agreement pursuant to which we provided HELIO billing and other support services in exchange for management fees. The management fees were determined based on our costs to provide the services, and management believed such fees were reasonable. Fees for services provided to HELIO are reflected as reductions to the associated expenses incurred by us to provide such services. During the years ended December 31, 2007 and 2008, fees received for services provided to HELIO were $1.6 million and $1.0 million, respectively.

Critical Accounting Policies and Estimates

        Set forth below is a discussion of the accounting policies and related estimates that we believe are the most critical to understanding our consolidated financial statements, financial condition and results of operations and which require complex management judgments, uncertainties and/or estimates. The preparation of financial statements in accordance with U.S. generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities, and the reported amounts of revenues and expenses during a reporting period; however, actual results could differ from those estimates. Management has discussed the development, selection and disclosure of the critical accounting policies and estimates with the Audit Committee of the Board of Directors. Information regarding our other accounting policies is included in the Notes to our Consolidated Financial Statements.

Revenue recognition

        We maintain relationships with certain broadband partners in which we provide services to customers using the "last mile" element of the telecommunications providers' networks. The term "last mile" generally refers to the element of telecommunications networks that is directly connected to homes and

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businesses. Generally, when we are the primary obligor in the transaction with the subscriber, have latitude in establishing prices, are the party determining the service specifications or have several but not all of these indicators, we record the revenue at the amount billed the subscriber. If we are not the primary obligor and/or the broadband partner has latitude in establishing prices, we record revenue associated with the related subscribers on a net basis, netting the cost of revenue associated with the service against the gross amount billed the customer and recording the net amount as revenue. The determination of whether we meet many of the attributes for gross and net revenue recognition is judgmental in nature and is based on an evaluation of the terms of each arrangement. A change in the determination of gross versus net revenue recognition would have an impact on the gross amounts of revenues and cost of revenues we recognize and the gross profit margin percentages in the period in which such determination is made and in subsequent periods; however, such a change in determination of revenue recognition would not affect net income.

Income taxes

        Significant judgment is required in evaluating our uncertain tax positions and determining our provision for income taxes. We establish reserves for tax-related uncertainties based on estimates of whether, and the extent to which, additional taxes will be due. These reserves are established when we believe that certain positions might be challenged despite our belief that our tax return positions are in accordance with applicable tax laws. We adjust these reserves in light of changing facts and circumstances, such as the closing of a tax audit, new tax legislation, or the change of an estimate. To the extent that the final tax outcome of these matters is different than the amounts recorded, such differences will affect the provision for income taxes in the period in which such determination is made. The provision for income taxes includes the effect of reserve provisions and changes to reserves that are considered appropriate, as well as the related net interest and penalties.

        We recognize deferred tax assets and liabilities using estimated future tax rates for the effect of temporary differences between the book and tax bases of recorded assets and liabilities, including net operating loss carryforwards. Management assesses the realizability of deferred tax assets and records a valuation allowance if it is more likely than not that all or a portion of the deferred tax assets will not be realized. We consider the probability of future taxable income and our historical profitability, among other factors, in assessing the amount of the valuation allowance. During the year ended December 31, 2009, we released $199.0 million of our valuation allowance related to our deferred tax assets. Of the valuation allowance release, $198.8 million was recorded as an income tax benefit in the Consolidated Statement of Operations and $0.2 million related to temporary differences and was recorded to accumulated other comprehensive income (loss) on the Consolidated Balance Sheet. These deferred tax assets relate primarily to net operating loss carryforwards which we determined we will more likely than not be able to utilize due to the generation of sufficient taxable income in the future. Our determination was made based on our past performance and our belief that we will generate sufficient taxable income in the future to utilize our tax assets. Significant judgment was involved in this determination, including projections of future taxable income. Changes in these estimates and assumptions could materially affect the amount or timing of the valuation allowance release.

        We continue to maintain a partial valuation allowance of $34.1 million against our net deferred tax assets, consisting primarily of net operating loss carryforwards. Of this amount, $31.7 million relates to net operating losses generated by the tax benefits of certain stock compensation arrangements. The valuation allowance will be removed upon utilization of these net operating losses as an adjustment to additional paid-in-capital. The remaining $2.4 million valuation allowance is retained for net operating losses in certain jurisdictions where we do not believe it is more likely than not that the net operating losses will be realized. Adjustments could be required in the future if we estimate that the amount of deferred tax assets to be realized is more or less than the net amount we have recorded. Any decrease in the valuation

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allowance could have the effect of increasing stockholders' equity and/or decreasing the income tax provision in the statement of operations.

Recoverability of noncurrent assets

Goodwill and indefinite-lived intangible assets

        We test goodwill and indefinite-lived intangible assets for impairment at least annually. We perform an impairment test of our goodwill and indefinite-lived intangible assets annually during the fourth quarter of our fiscal year or when events and circumstances indicate the indefinite-lived intangible assets might be permanently impaired. During the fourth quarter of 2008, our annual impairment test concluded that goodwill and certain intangible assets recorded as a result of our April 2006 acquisition of New Edge were impaired and we recorded non-cash impairment charges related to the New Edge reporting unit of $64.0 million for goodwill and $3.1 million for the indefinite-lived trade name. During the fourth quarter of 2009, our annual impairment test concluded that goodwill and certain intangible assets recorded as a result of the New Edge acquisition were further impaired and we recorded non-cash impairment charges related to the New Edge reporting unit of $23.9 million for goodwill and $0.2 million for the indefinite-lived trade name. As a result, there is no remaining carrying value related to New Edge goodwill.

        Application of the goodwill impairment test requires judgment, including the identification of reporting units, assigning assets and liabilities to reporting units, assigning goodwill to reporting units, and determining the fair value of each reporting unit. Significant judgments required to estimate the fair value of reporting units include estimating future cash flows, determining appropriate discount rates, growth rates and other assumptions. Changes in these estimates and assumptions could materially affect the determination of fair value for each reporting unit which could trigger impairment or impact the amount of the impairment.

        Although we operate two reportable segments, we have identified three reporting units for evaluating goodwill, which are Consumer Services (which consists of our consumer product offerings including narrowband and broadband access, VoIP and value-added services), New Edge and Web Hosting. The Consumer Services reportable segment is one reporting unit, while the Business Services reportable segment consists of two reporting units, New Edge and Web Hosting. Each of these reporting units constitutes a business for which discrete financial information is available and segment management regularly reviews the operating results. Goodwill resulting from our New Edge acquisition in 2006 was allocated to the New Edge reporting unit. Goodwill resulting from all other acquisitions related to consumer products and was allocated to the Consumer Services reporting unit. No goodwill is allocated to our Web Hosting reporting unit.

        Impairment testing of goodwill is required at the reporting unit level and involves a two-step process. The first step of the impairment test involves comparing the estimated fair value of our reporting units with the reporting unit's carrying amount, including goodwill. We estimate the fair values of our reporting units primarily using the income approach valuation methodology that includes the discounted cash flow method, taking into consideration the market approach and certain market multiples as a validation of the values derived using the discounted cash flow methodology. The discounted cash flows for each reporting unit are based on discrete financial forecasts developed by management for planning purposes. Cash flows beyond the discrete forecasts are estimated using a terminal value calculation, which incorporates historical and forecasted financial trends for each identified reporting unit.

        If we determine that the carrying value of a reporting unit exceeds its estimated fair value, we perform a second step. The implied fair value of goodwill is determined in the same manner as utilized to recognize goodwill in a business combination. The implied fair value of goodwill is measured as the excess of the fair value of the reporting unit over the amounts assigned to its assets and liabilities. Any impairment loss is measured by the amount the carrying value of goodwill exceeded the implied fair value of the goodwill.

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        The impairment test for our indefinite-lived intangible assets, which consist of trade names, involves a comparison of the estimated fair value of the intangible asset with its carrying value. If the carrying value of the intangible asset exceeds its fair value, an impairment loss is recognized in an amount equal to that excess. We determine the fair value of our trade names using the royalty savings method, in which the fair value of the asset is calculated based on the present value of the royalty stream that we are saving by owning the asset. Significant judgments required to estimate the fair value include assumptions about royalty rates and the selection of appropriate discount rates. Changes in these estimates and assumptions could materially affect the determination of fair value for our indefinite-lived intangible assets which could impact the amount of an impairment.

Long-lived assets

        For noncurrent assets such as property and equipment, definite-lived intangible assets and investments in other companies, we perform tests of impairment when certain events or changes in circumstances indicate that the carrying amount may not be recoverable. Our tests involve critical estimates reflecting management's best assumptions and estimates related to, among other factors, subscriber additions, churn, prices, marketing spending, operating costs and capital spending. Significant judgment is involved in estimating these factors, and they include inherent uncertainties. Management periodically evaluates and updates the estimates based on the conditions that influence these factors. The variability of these factors depends on a number of conditions, including uncertainty about future events, and thus our accounting estimates may change from period to period. If other assumptions and estimates had been used in the current period, the balances for noncurrent assets could have been materially impacted. Furthermore, if management uses different assumptions or if different conditions occur in future periods, future operating results could be materially impacted.

Fair value measurements

        We utilize unobservable (Level 3) inputs in determining the fair value of certain assets, which included auction rate securities with a carrying value and fair value of $42.9 million as of December 31, 2009 and our put right with a carrying value and fair value of $5.2 million as of December 31, 2009.

        Our auction rate securities are variable-rate debt instruments whose underlying agreements have contractual maturities of up to 40 years, but have interest rate reset periods at pre-determined intervals, usually every 28 days. These securities are predominantly secured by student loans guaranteed by state related higher education agencies and reinsured by the U.S. Department of Education. Beginning in February 2008, auctions for these securities failed to attract sufficient buyers, resulting in us continuing to hold such securities. Prior to February 2008, due to the auction process, quoted market prices were readily available, which would have qualified as Level 1. However, due to events in credit markets beginning in February 2008, these securities did not have readily determinable market values and were not liquid. The fair values of our auction rate securities as of December 31, 2008 and 2009 were estimated utilizing a discounted cash flow analysis. This analysis considered, among other items, the collateralization underlying the security investments, the creditworthiness of the counterparty, and the timing and value of expected future cash flows. These securities were also compared, when possible, to other observable market data with similar characteristics to the securities held by us. Due to the failed auctions, we classify these instruments within Level 3. We elected the fair value option for the put right to offset the fair value changes of the auction rate securities. The fair value of the put right is estimated using a discounted cash flow analysis and is classified within Level 3.

        Determining the fair values of our auction rate securities and put right requires judgment. If other assumptions and estimates had been used in the current period, the fair value of our auction rate securities and put right could have been materially impacted. Furthermore, if management uses different assumptions in future periods, future operating results could be materially impacted.

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Restructuring and facility exit costs

        Over the past few years, we have closed facilities, reduced personnel and outsourced certain functions to streamline our business. Restructuring-related liabilities, including reserves for facility exit costs, include estimates for, among other things, severance payments and amounts due under lease obligations, net of estimated sublease income, if any. Key variables in determining such estimates include estimating the future operating expenses to be incurred for the facilities, anticipating the timing and amounts of sublease rental payments, tenant improvement costs and brokerage and other related costs. We accrue the estimated future costs of any lease obligation, net of estimated sublease income, as facility exit and restructuring costs in the Consolidated Statement of Operations.

        If the real estate and leasing markets change or if existing subtenants experience financial difficulty, especially given the weak economy, sublease amounts could vary significantly from the amounts estimated, resulting in a material change to our recorded liability. We record any adjustments to liabilities associated with facility exit costs as facility exit and restructuring costs. We periodically evaluate and, if necessary, adjust our estimates based on currently-available information and such adjustments have periodically resulted in additional expense. Adjustments to our recorded liabilities for future lease obligations associated with vacated facilities could adversely or favorably affect future operating results.

Recently Issued Accounting Pronouncements

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

        In December 2009, the FASB issued new guidance regarding variable interest entities ("VIEs"). VIEs are entities that either do not have equity investors with proportionate economic and voting rights or have equity investors that do not provide sufficient financial resources for the entity to support its activities. The new guidance requires a qualitative approach to identifying a controlling financial interest in a VIE, and requires ongoing assessment of whether an entity is a VIE and whether an interest in a VIE makes the holder the primary beneficiary of the VIE. The new guidance is effective for annual reporting periods beginning after November 15, 2009. We do not expect the adoption of this new guidance to have a material impact on its consolidated financial statements.

Adoption of Recent Accounting Pronouncements

        Codification.     In the third quarter of 2009, we adopted the FASB Accounting Standards Codification ("ASC"). The ASC became the single official source of authoritative U.S. generally accepted accounting principles ("GAAP") recognized by the FASB, other than guidance issued by the Securities and Exchange Commission. The adoption of the ASC did not have a material impact on our financial statements. However, the adoption of the ASC changed our references to GAAP in our consolidated financial statements.

        Convertible Debt.     On January 1, 2009, we adopted new accounting guidance related to accounting for convertible debt instruments that may be settled in cash upon conversion. The new accounting guidance requires that the liability and equity components of convertible debt instruments that may be settled in cash upon conversion (including partial cash settlement) be separately accounted for in a manner that reflects an issuer's non-convertible debt borrowing rate. The resulting debt discount is accreted over the

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period the convertible debt is expected to be outstanding as additional non-cash interest expense. Retrospective application to all periods presented is required. The adoption of this new guidance on January 1, 2009 affected the accounting for our Notes, which were issued in November 2006. Upon adoption, we recorded an adjustment to increase additional paid-in capital as of the November 2006 issuance date by approximately $62.1 million. We are accreting the resulting debt discount to interest expense over the estimated five-year life of the Notes, which represents the first redemption date of November 2011. Upon adoption, we also recorded an adjustment to decrease additional paid-in capital and other long-term assets by approximately $1.8 million to reclassify debt issuance costs related to the equity component of the Notes. We recorded a pre-tax adjustment of approximately $22.3 million to accumulated deficit that represents accretion of the debt discount and decrease in amortization of debt issuance costs during the years ended December 31, 2006, 2007 and 2008, recognized additional non-cash interest expense of $12.2 million during the year ending December 31, 2009 and will recognize additional non-cash interest expense of $13.4 million and $12.4 million during the years ending December 31, 2010 and 2011, respectively, for accretion of the debt discount and decrease in amortization of debt issuance costs. As a result of the adoption of this new guidance, we reduced income from continuing operations and net income for the year ended December 31, 2009 by $12.2 million and reduced basic and diluted earnings per share by $0.11 per share. We also recorded a deferred tax liability for temporary tax differences. However, this was offset by a corresponding decrease in the valuation allowance for deferred tax assets.

        The following tables present the effect of the adoption of this new guidance on our affected financial statement line items for the years ended December 31, 2007 and 2008 and as of December 31, 2008:

 
  Year Ended December 31, 2007   Year Ended December 31, 2008  
 
  As Originally
Reported
  As
Adjusted
  Effect of
Change
  As Originally
Reported
  As
Adjusted
  Effect of
Change
 
 
  (in thousands, except per share data)
 

Statement of Operations:

                                     

Interest income (expense) and other, net

  $ 12,824   $ 2,824   $ (10,000 ) $ (1,381 ) $ (12,409 ) $ (11,028 )

Income (loss) from continuing operations

    (54,795 )   (64,795 )   (10,000 )   198,118     187,090     (11,028 )

Net income (loss)

    (135,097 )   (145,097 )   (10,000 )   189,612     178,584     (11,028 )

Basic net income (loss) per share

                                     
 

Continuing operations

  $ (0.45 ) $ (0.53 ) $ (0.08 ) $ 1.81   $ 1.71   $ (0.10 )
 

Basic net income per share

    (1.11 )   (1.19 )   (0.08 )   1.73     1.63     (0.10 )

Diluted net income (loss) per share

                                     
 

Continuing operations

  $ (0.45 ) $ (0.53 ) $ (0.08 ) $ 1.78   $ 1.68   $ (0.10 )
 

Diluted net income per share

    (1.11 )   (1.19 )   (0.08 )   1.71     1.61     (0.10 )

 

 
  As of December 31, 2008  
 
  As Originally
Reported
  As
Adjusted
  Effect of
Change
 
 
  (in thousands)
 

Balance Sheet:

                   

Other long-term assets

  $ 5,725   $ 4,698   $ (1,027 )

Long-term debt

    258,750     219,733     (39,017 )

Additional paid-in capital

    2,075,571     2,135,887     60,316  

Accumulated deficit

    (994,507 )   (1,016,833 )   (22,326 )

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Item 7a.    Quantitative and Qualitative Disclosures about Market Risk.

Interest Rate Risk

        The Company is exposed to interest rate risk with respect to its investments in marketable securities. A change in prevailing interest rates may cause the fair value of the Company's investments to fluctuate. For example, if the Company holds a security that was issued with a fixed interest rate at the then-prevailing rate and the prevailing interest rate later rises, the fair value of its investment may decline. To minimize this risk, the Company has historically held many investments until maturity, and as a result, the Company receives interest and principal amounts pursuant to the underlying agreements. To further mitigate risk, the Company has historically maintained its portfolio of investments in a variety of securities, including government agency notes, asset-backed debt securities (including auction rate debt securities) and commercial paper, all of which bear a minimum short-term rating of A1/P1 or a minimum long-term rating of A/A2. As of December 31, 2008 and 2009, net unrealized losses in these investments were not material. In general, money market funds are not subject to market risk because the interest paid on such funds fluctuates with the prevailing interest rate.

        As of December 31, 2008, our investments in marketable securities consisted of $47.8 million of auction rate securities with a weighted average interest rate of 2.0%. As of December 31, 2009, our investments in marketable securities included $42.9 million of auction rate securities with a weighted average interest rate of 1.42%. These securities are variable-rate debt instruments whose underlying agreements have contractual maturities of up to 40 years. These securities are issued by various municipalities and state regulated higher education agencies and are predominantly secured by pools of student loans guaranteed by the agencies and reinsured by the U.S. Department of Education. Liquidity for these auction rate securities is typically provided by an auction process that resets the applicable interest rate at pre-determined intervals, usually every 28 days. In October 2008, we entered into an agreement with the broker that sold us our auction rate securities that gives us the right to sell our existing auction rate securities back to the broker at par plus accrued interest, beginning on June 30, 2010 until July 2, 2012 (herein referred to as "put right"). We elected a one-time transfer of our auction rate securities from the available-for-sale category to the trading category. We also elected the fair value option for the put right to offset the fair value changes of the auction rate securities.

        We are also exposed to interest rate risk with respect to our convertible senior notes due November 15, 2026. The fair value of our convertible senior notes may be adversely impacted due to a rise in interest rates. In general, securities with longer maturities are 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 year until November 15, 2011, and 3.50% interest per year thereafter. As of December 31, 2008 and 2009, the principal amount of our convertible senior notes was $258.8 million and the fair value was approximately $236.6 million and $279.8 million, respectively, which was based on the quoted market price.

Equity Risk

        We are exposed to equity price risk as it relates to changes in the market value of our equity investments. We invest in equity instruments of public and private companies for operational and strategic purposes. These securities are subject to significant fluctuations in fair market value due to volatility of the stock market and the industries in which the companies operate. We typically do not attempt to reduce or eliminate our market exposure in these equity instruments.

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        The following table presents the carrying value and fair value of our financial instruments subject to equity risk as of December 31, 2008 and 2009:

 
  As of December 31, 2008   As of December 31, 2009  
 
  Carrying
Amount
  Estimated
Fair Value
  Carrying
Amount
  Estimated
Fair Value
 
 
  (dollars in thousands)
 

Investments in other companies for which it is:

                         
 

Practicable to estimate fair value

  $ 1,580   $ 1,580   $ 1,529   $ 1,529  
 

Not practicable to estimate fair value

    9,300     N/A         N/A  

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Item 8.    Financial Statements And Supplementary Data.


EARTHLINK, INC.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

 
  Page

Reports of Independent Registered Public Accounting Firm

  62

Consolidated Balance Sheets as of December 31, 2008 and 2009

 
64

Consolidated Statements of Operations for the years ended December 31, 2007, 2008 and 2009

 
65

Consolidated Statements of Stockholders' Equity and Comprehensive Income (Loss) for the years ended December 31, 2007, 2008 and 2009

 
66

Consolidated Statements of Cash Flows for the years ended December 31, 2007, 2008 and 2009

 
67

Notes to Consolidated Financial Statements

 
68

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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

The Board of Directors and
Stockholders of EarthLink, Inc.

        We have audited the accompanying consolidated balance sheets of EarthLink, Inc. as of December 31, 2008 and 2009, and the related consolidated statements of operations, stockholders' equity and comprehensive income (loss), and cash flows for each of the three years in the period ended December 31, 2009. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.

        We conducted our audits in accordance with standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, 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 statements referred to above present fairly, in all material respects, the consolidated financial position of EarthLink, Inc. at December 31, 2008 and 2009, and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 2009, in conformity with U.S. generally accepted accounting principles.

        As discussed in Note 2 to the consolidated financial statements, the Company changed its method of accounting for convertible debt instruments with the adoption of the guidance originally issued in FASB Staff Position APB 14-1, Accounting for Convertible Debt Instruments That May Be Settled in Cash upon Conversion (Including Partial Cash Settlement) , (codified primarily in FASB ASC Topic 470, Debt ) effective January 1, 2009.

        We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), EarthLink, Inc.'s internal control over financial reporting as of December 31, 2009, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated February 26, 2010 expressed an unqualified opinion thereon.

                      /s/ Ernst & Young LLP

Atlanta, Georgia
February 26, 2010

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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM ON INTERNAL
CONTROL OVER FINANCIAL REPORTING

The Board of Directors and
Stockholders of EarthLink, Inc.

        We have audited EarthLink, Inc.'s internal control over financial reporting as of December 31, 2009, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (the COSO criteria). EarthLink, Inc.'s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting included in the accompanying Management's Report on Internal Control Over Financial Reporting. Our responsibility is to express an opinion on the Company's internal control over financial reporting based on our audit.

        We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.

        A company's internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company's internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company's assets that could have a material effect on the financial statements.

        Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

        In our opinion, EarthLink, Inc. maintained, in all material respects, effective internal control over financial reporting as of December 31, 2009, based on the COSO criteria.

        We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets as of December 31, 2008 and 2009, and the related consolidated statements of operations, stockholders' equity and comprehensive income (loss), and cash flows for each of the three years in the period ended December 31, 2009 of EarthLink, Inc. and our report dated February 26, 2010 expressed an unqualified opinion thereon.

                      /s/ Ernst & Young LLP

Atlanta, Georgia
February 26, 2010

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EARTHLINK, INC.

CONSOLIDATED BALANCE SHEETS

(in thousands, except per share data)

 
  December 31,  
 
  2008   2009  

ASSETS

 

Current assets:

             
 

Cash and cash equivalents

  $ 486,564   $ 610,995  
 

Marketable securities

        84,966  
 

Accounts receivable, net of allowance of $4,048 and $1,736 as of December 31, 2008 and 2009, respectively

    30,569     20,560  
 

Prepaid expenses

    6,445     4,374  
 

Deferred income taxes, net

    20,254     46,063  
 

Other current assets

    15,452     16,423  
           
   

Total current assets

    559,284     783,381  

Long-term marketable securities

    47,809      

Long-term investments

    20,708      

Property and equipment, net

    37,246     34,267  

Deferred income taxes, net

    43,757     153,132  

Purchased intangible assets, net

    19,552     11,550  

Goodwill

    112,812     88,920  

Other long-term assets

    4,698     3,368  
           
   

Total assets

  $ 845,866   $ 1,074,618  
           

LIABILITIES AND STOCKHOLDERS' EQUITY

 

Current liabilities:

             
 

Accounts payable

  $ 13,109   $ 6,270  
 

Accrued payroll and related expenses

    37,470     25,093  
 

Other accrued liabilities

    39,415     34,659  
 

Deferred revenue

    33,649     25,728  
 

Convertible senior notes, net of discount of $26,502 as of December 31, 2009

        232,248  
           
   

Total current liabilities

    123,643     323,998  

Convertible senior notes, net of discount of $39,017 as of December 31, 2008

    219,733      

Other long-term liabilities

    16,015     16,596  
           
   

Total liabilities

    359,391     340,594  

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, 2008 and 2009

         
 

Common stock, $0.01 par value, 300,000 shares authorized, 188,264 and 190,472 shares issued as of December 31, 2008 and 2009, respectively, and 108,516 and 107,132 shares outstanding as of December 31, 2008 and 2009, respectively

    1,883     1,905  
 

Additional paid-in capital

    2,135,887     2,118,100  
 

Accumulated deficit

    (1,016,833 )   (729,715 )
 

Treasury stock, at cost, 79,748 and 83,340 shares,

             
   

respectively, as of December 31, 2008 and 2009

    (634,420 )   (656,760 )
 

Accumulated other comprehensive income (loss)

    (42 )   494  
           
   

Total stockholders' equity

    486,475     734,024  
           
   

Total liabilities and stockholders' equity

  $ 845,866   $ 1,074,618  
           

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

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EARTHLINK, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS

 
  Year Ended December 31,  
 
  2007   2008   2009  
 
  (in thousands, except per share data)
 

Revenues

  $ 1,215,994   $ 955,577   $ 723,729  

Operating costs and expenses:

                   
 

Cost of revenues

    442,697     360,920     273,755  
 

Sales and marketing

    291,105     98,212     59,474  
 

Operations and customer support

    221,443     136,797     98,435  
 

General and administrative

    128,412     93,878     72,398  
 

Amortization of intangible assets

    14,672     13,349     7,749  
 

Impairment of goodwill and intangible assets

    4,250     78,672     24,145  
 

Facility exit and restructuring costs

    65,381     9,142     5,615  
               
   

Total operating costs and expenses

    1,167,960     790,970     541,571  
               
   

Income from operations

   
48,034
   
164,607
   
182,158
 

Net losses of equity affiliate

    (111,295 )        

Gain (loss) on investments, net

    (5,585 )   2,708     (1,321 )

Interest income (expense) and other, net

    2,824     (12,409 )   (19,804 )
               
   

Income (loss) from continuing operations before income taxes

    (66,022 )   154,906     161,033  

Income tax benefit

    1,227     32,184     126,085  
               
   

Income (loss) from continuing operations

    (64,795 )   187,090     287,118  

Loss from discontinued operations, net of tax

    (80,302 )   (8,506 )    
               
   

Net income (loss)

  $ (145,097 ) $ 178,584   $ 287,118  
               

Basic net income (loss) per share

                   
 

Continuing operations

  $ (0.53 ) $ 1.71   $ 2.69  
 

Discontinued operations

    (0.66 )   (0.08 )    
               
 

Basic net income (loss) per share

  $ (1.19 ) $ 1.63   $ 2.69  
               
 

Basic weighted average common shares outstanding

    121,633     109,531     106,909  
               

Diluted net income (loss) per share

                   
 

Continuing operations

  $ (0.53 ) $ 1.68   $ 2.66  
 

Discontinued operations

    (0.66 )   (0.08 )    
               
 

Diluted net income (loss) per share

  $ (1.19 ) $ 1.61   $ 2.66  
               
 

Diluted weighted average common shares outstanding

    121,633     111,051     108,084  
               

Dividends declared per common share

  $   $   $ 0.28  
               

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

65


EARTHLINK, INC.

CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY AND COMPREHENSIVE INCOME (LOSS)

 
   
   
   
   
   
   
   
  Accumulated
Other
Comprehensive
Income
(Loss)
   
   
 
 
  Common Stock    
   
   
  Treasury Stock    
   
 
 
  Additional
Paid-in
Capital
   
  Accumulated
Deficit
  Total
Stockholders'
Equity
  Total
Comprehensive
Income (Loss)
 
 
  Shares   Amount   Warrants   Shares   Amount  
 
  (in thousands)
 

Balance as of December 31, 2006

    184,545   $ 1,845   $ 2,076,894   $ 259   $ (1,046,293 )   (61,911 ) $ (508,232 ) $ (6,791 ) $ 517,682        

Issuance of common stock pursuant to exercise of stock options and vesting of restricted stock units

    1,796     18     9,707                         9,725        

Issuance of common stock for acquisition of New Edge

    49     1     379                         380        

Issuance of common stock

    100     1     724                         725        

Exercise of warrants

              259     (259 )                          

Issuance of phantom share units

            45                         45        

Stock-based compensation expense

            19,576                         19,576        

Repurchase of common stock

                        (14,032 )   (94,332 )       (94,332 )      

Reclassification adjustment for realized losses on certain investments

                                4,770     4,770        

Unrealized holding gains on certain investments, net of tax

                                1,044     1,044   $ 1,044  

Net loss

                    (145,097 )               (145,097 )   (145,097 )
                                           

Total comprehensive loss

                                                        $ (144,053 )
                                                             

Balance as of December 31, 2007

    186,490     1,865     2,107,584         (1,191,390 )   (75,943 )   (602,564 )   (977 )   314,518        
                                             

Cumulative effect of change in accounting principle

                    (4,027 )               (4,027 )      

Issuance of common stock pursuant to exercise of

                                                           

stock options and vesting of restricted stock units

    1,774     18     5,728                         5,746        

Tax benefit from equity awards

            1,017                         1,017        

Termination of convertible note hedge and warrant agreements

            1,425                         1,425        

Stock-based compensation expense

            20,133                         20,133        

Repurchase of common stock

                        (3,805 )   (31,856 )       (31,856 )      

Reclassification adjustment for realized gains and losses on certain investments

                                893     893        

Unrealized holding gains on certain investments, net of tax

                                42     42   $ 42  

Net income

                    178,584                 178,584     178,584  
                                           

Total comprehensive income

                                                        $ 178,626  
                                                             

Balance as of December 31, 2008

    188,264     1,883     2,135,887         (1,016,833 )   (79,748 )   (634,420 )   (42 )   486,475        
                                             

Issuance of common stock pursuant to exercise of stock options and vesting of restricted stock units

    2,208     22     5,054                         5,076        

Tax withholdings related to net share settlements of restricted stock units and stock options

            (5,450 )                       (5,450 )      

Dividends paid on shares outstanding and restricted stock units

            (30,006 )                       (30,006 )      

Dividends payable on restricted stock units

            (616 )                       (616 )      

Stock-based compensation expense

            13,231                         13,231        

Repurchase of common stock

                        (3,592 )   (22,340 )       (22,340 )      

Unrealized holding gains on certain investments, net of tax

                                536     536   $ 536