EarthLink Holdings Corp.
EARTHLINK INC (Form: 10-Q, Received: 08/07/2007 06:04:54)

 

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

FORM 10-Q

x

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

 

 

 

For the quarterly period ended June 30, 2007

 

 

OR

 

 

o

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

 

 

 

For the transition period from         to       

 

Commission File Number: 001-15605

EARTHLINK, INC.

(Exact name of registrant as specified in its charter)

Delaware

 

58-2511877

(State or other jurisdiction of incorporation or organization)

 

(I.R.S. Employer Identification No.)

 

 

 

1375 Peachtree St., Atlanta, Georgia

 

30309

(Address of principal executive offices)

 

(Zip Code)

 

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


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


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 x No o

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

Large accelerated filer x      Accelerated filer o       Non-accelerated filer o

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

As of July 31, 2007, 123,663,623 shares of common stock, $.01 par value per share, were outstanding.

 




EARTHLINK, INC.
Quarterly Report on Form 10-Q
For the Quarterly Period Ended June 30, 2007

TABLE OF CONTENTS

Part I

 

Item 1. Financial Statements

 

 

 

 

 

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

 

 

 

 

 

Item 3. Quantitative and Qualitative Disclosures About Market Risk

 

 

 

 

 

Item 4. Controls and Procedures

 

 

 

 

 

Part II

 

 

 

Item 1. Legal Proceedings

 

 

 

 

 

Item 1A. Risk Factors

 

 

 

 

 

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

 

 

 

 

 

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

 

 

 

 

 

Item 5. Other Information

 

 

 

 

 

Item 6. Exhibits

 

 

 

 

 

Signatures

 

 

 




PART I

Item 1.  Financial Statements.

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

 

 

December 31,

 

June 30,

 

 

 

2006

 

2007

 

 

 

 

 

(unaudited)

 

 

 

 

 

 

 

ASSETS

 

 

 

 

 

Current assets:

 

 

 

 

 

Cash and cash equivalents

 

$

158,369

 

$

127,623

 

Investments in marketable securities

 

214,947

 

229,546

 

Accounts receivable, net of allowance of $8,062 and $9,810 as of December 31, 2006 and June 30, 2007, respectively

 

51,054

 

50,989

 

Prepaid expenses

 

14,831

 

11,498

 

Other current assets

 

17,549

 

16,073

 

Total current assets

 

456,750

 

435,729

 

Long-term investments in marketable securities

 

21,460

 

26,198

 

Property and equipment, net

 

96,620

 

113,623

 

Investment in equity affiliate

 

61,743

 

11,887

 

Investments in other companies

 

59,325

 

55,123

 

Purchased intangible assets, net

 

59,798

 

56,083

 

Goodwill

 

202,277

 

202,277

 

Other long-term assets

 

10,066

 

10,888

 

Total assets

 

$

968,039

 

$

911,808

 

 

 

 

 

 

 

LIABILITIES AND STOCKHOLDERS’ EQUITY

 

 

 

 

 

Current liabilities:

 

 

 

 

 

Trade accounts payable

 

$

41,298

 

$

31,882

 

Accrued payroll and related expenses

 

41,079

 

35,239

 

Other accounts payable and accrued liabilities

 

94,882

 

91,040

 

Deferred revenue

 

53,511

 

49,958

 

Total current liabilities

 

230,770

 

208,119

 

 

 

 

 

 

 

Long-term debt

 

258,750

 

258,750

 

Other long-term liabilities

 

19,855

 

26,730

 

Total liabilities

 

509,375

 

493,599

 

 

 

 

 

 

 

Stockholders’ equity:

 

 

 

 

 

Convertible preferred stock, $0.01 par value, 100,000 shares authorized, 0 shares issued and outstanding as of December 31, 2006 and June 30, 2007

 

 

 

Common stock, $0.01 par value, 300,000 shares authorized, 184,545 and 185,477 shares issued as of December 31, 2006 and June 30, 2007, respectively, and 122,634 and 123,566 shares outstanding as of December 31, 2006 and June 30, 2007, respectively

 

1,845

 

1,855

 

Additional paid-in capital

 

2,016,578

 

2,033,219

 

Warrants to purchase common stock

 

259

 

231

 

Accumulated deficit

 

(1,044,995

)

(1,095,275

)

Treasury stock, at cost, 61,911 shares as of December 31, 2006 and June 30, 2007

 

(508,232

)

(508,232

)

Unrealized losses on investments

 

(6,791

)

(13,589

)

Total stockholders’ equity

 

458,664

 

418,209

 

Total liabilities and stockholders’ equity

 

$

968,039

 

$

911,808

 

 

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

1




EARTHLINK, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

 

 

Three Months Ended

 

Six Months Ended

 

 

 

June 30,

 

June 30,

 

 

 

2006

 

2007

 

2006

 

2007

 

 

 

(in thousands, except per share data)

 

 

 

(unaudited)

 

 

 

 

 

 

 

 

 

 

 

Revenues

 

$

332,096

 

$

312,203

 

$

641,808

 

$

636,609

 

 

 

 

 

 

 

 

 

 

 

Operating costs and expenses:

 

 

 

 

 

 

 

 

 

Service and equipment costs

 

110,301

 

110,472

 

200,373

 

221,630

 

Sales incentives

 

2,392

 

5,367

 

4,669

 

10,075

 

Total cost of revenues

 

112,693

 

115,839

 

205,042

 

231,705

 

 

 

 

 

 

 

 

 

 

 

Sales and marketing

 

91,172

 

76,186

 

195,015

 

174,817

 

Operations and customer support

 

66,553

 

65,936

 

127,221

 

131,946

 

General and administrative

 

31,441

 

30,517

 

62,651

 

74,870

 

Amortization of intangible assets

 

3,122

 

3,542

 

5,035

 

7,038

 

Facility exit and restructuring costs

 

(117

)

 

(117

)

 

Total operating costs and expenses

 

304,864

 

292,020

 

594,847

 

620,376

 

 

 

 

 

 

 

 

 

 

 

Income from operations

 

27,232

 

20,183

 

46,961

 

16,233

 

Net losses of equity affiliate

 

(15,351

)

(40,054

)

(22,942

)

(69,400

)

Gain on investments in other companies

 

352

 

210

 

352

 

210

 

Interest income and other, net

 

4,334

 

3,597

 

8,550

 

7,100

 

Income (loss) before income taxes

 

16,567

 

(16,064

)

32,921

 

(45,857

)

Provision for income taxes

 

 

226

 

 

395

 

Net income (loss)

 

$

16,567

 

$

(16,290

)

$

32,921

 

$

(46,252

)

 

 

 

 

 

 

 

 

 

 

Basic net income (loss) per share

 

$

0.12

 

$

(0.13

)

$

0.25

 

$

(0.38

)

Diluted net income (loss) per share

 

$

0.12

 

$

(0.13

)

$

0.24

 

$

(0.38

)

Basic weighted average common shares outstanding

 

132,779

 

123,257

 

132,147

 

123,159

 

Diluted weighted average common shares outstanding

 

134,897

 

123,257

 

134,718

 

123,159

 

 

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

2




EARTHLINK, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

 

 

Six Months Ended

 

 

 

June 30,

 

 

 

2006

 

2007

 

 

 

(in thousands)

 

 

 

(unaudited)

 

Cash flows from operating activities:

 

 

 

 

 

Net income (loss)

 

$

32,921

 

$

(46,252

)

Adjustments to reconcile net income (loss) to net cash provided by operating activities:

 

 

 

 

 

Depreciation and amortization

 

21,810

 

26,118

 

Loss on disposals of fixed assets

 

809

 

7

 

Net losses of equity affiliate

 

22,942

 

69,400

 

Gain on investments in other companies

 

(352

)

(210

)

Stock-based compensation

 

7,427

 

10,813

 

Decrease in accounts receivable, net

 

5,048

 

39

 

Decrease in prepaid expenses and other assets

 

837

 

1,275

 

Decrease in accounts payable and accrued and other liabilities

 

(30,686

)

(24,709

)

Decrease in deferred revenue

 

(1,622

)

(3,277

)

Other

 

(514

)

(43

)

Net cash provided by operating activities

 

58,620

 

33,161

 

 

 

 

 

 

 

Cash flows from investing activities:

 

 

 

 

 

Purchases of property and equipment

 

(13,857

)

(26,828

)

Purchases of subscriber bases

 

(1,795

)

(2,949

)

Proceeds from sales of fixed assets

 

8

 

36

 

Investments in marketable securities

 

 

 

 

 

Purchases

 

(60,387

)

(232,536

)

Sales and maturities

 

162,060

 

213,202

 

Purchase of business, net

 

(108,663

)

 

Investments in and net advances to equity affiliate

 

(39,433

)

(19,474

)

Investments in other companies

 

(60,000

)

 

Other investing activities

 

(803

)

210

 

Net cash used in investing activities

 

(122,870

)

(68,339

)

 

 

 

 

 

 

Cash flows from financing activities:

 

 

 

 

 

Repayment of note payable

 

(2,000

)

 

Principal payments under capital lease obligations

 

(14

)

(15

)

Proceeds from exercises of stock options and other

 

3,198

 

4,447

 

Repurchases of common stock

 

(21,142

)

 

Net cash (used in) provided by financing activities

 

(19,958

)

4,432

 

 

 

 

 

 

 

Net decrease in cash and cash equivalents

 

(84,208

)

(30,746

)

Cash and cash equivalents, beginning of period

 

173,294

 

158,369

 

Cash and cash equivalents, end of period

 

$

89,086

 

$

127,623

 

 

 

 

 

 

 

Significant non-cash transactions:

 

 

 

 

 

Assets acquired pursuant to capital lease agreement

 

$

 

$

8,117

 

 

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

3




EARTHLINK, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
UNAUDITED

1.  Organization

EarthLink, Inc. (“EarthLink” or the “Company”) is a total communications provider, providing integrated communication services and related value-added services to individual consumers and business customers utilizing Internet Protocol, or IP, based technologies.  EarthLink’s core service offerings are dial-up and wireline broadband Internet access services and value-added services. EarthLink’s growth initiatives have recently included IP-based voice services, municipal wireless broadband services and services for business customers.

2.  Basis of Presentation

Basis of Presentation

The condensed consolidated financial statements of EarthLink, which include the accounts of its wholly-owned subsidiaries, for the three and six months ended June 30, 2006 and 2007 and the related footnote information are unaudited and have been prepared on a basis consistent with the Company’s audited consolidated financial statements as of December 31, 2006 contained in the Company’s Annual Report on Form 10-K, as amended, as filed with the Securities and Exchange Commission (the “Annual Report”).  All significant intercompany transactions have been eliminated.

These financial statements should be read in conjunction with the audited consolidated financial statements and the related notes thereto contained in the Company’s Annual Report.  In the opinion of management, the accompanying unaudited financial statements contain all adjustments (consisting of normal recurring adjustments), which management considers necessary to present fairly the Company’s financial position, results of operations and cash flows for the interim periods presented.  The results of operations for the three and six months ended June 30, 2007 are not necessarily indicative of the results anticipated for the entire year ending December 31, 2007.

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

Adoption of Recent Accounting Pronouncements

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

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

Reclassifications

Certain amounts in the prior period financial statements have been reclassified to conform to the current period presentation.

4




3.  Recent Accounting Pronouncements

In September 2006, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards (“SFAS”) No. 157, “Fair Value Measurements,” which establishes a framework for reporting fair value and expands disclosures required for fair value measurements. SFAS No. 157 is effective for financial statements issued for fiscal years beginning after November 15, 2007 and interim periods within those fiscal years. The Company is currently assessing the impact of the adoption of this standard on its financial statements.

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

4.  Earnings per Share

Net income (loss) per share has been computed according to SFAS No. 128, “Earnings per Share,” which requires a dual presentation of basic and diluted earnings per share (“EPS”).  Basic EPS represents net income divided by the weighted average number of common shares outstanding during a reported period.  Diluted EPS reflects the potential dilution that could occur if securities or other contracts to issue common stock, including stock options, warrants, restricted stock units, phantom share units and contingently issuable shares (commonly and hereinafter referred to as “Common Stock Equivalents”), were exercised or converted into common stock. The dilutive effect of outstanding stock options, warrants and restricted stock units is reflected in diluted earnings per share by application of the treasury stock method. Phantom share units and contingently issuable shares are reflected on an if-converted basis. In applying the treasury stock method for stock-based compensation arrangements, the assumed proceeds were computed as the sum of the amount the employee must pay upon exercise and the amounts of compensation cost attributed to future services and not yet recognized.

The following table sets forth the computation for basic and diluted net income per share for the three and six months ended June 30, 2006:

 

Three Months

 

Six Months

 

 

 

Ended

 

Ended

 

 

 

June 30, 2006

 

June 30, 2006

 

 

 

(in thousands, except per share data)

 

 

 

 

 

 

 

Net income (A)

 

$

16,567

 

$

32,921

 

 

 

 

 

 

 

Basic weighted average common shares outstanding (B)

 

132,779

 

132,147

 

Dilutive effect of Common Stock Equivalents

 

2,118

 

2,571

 

Diluted weighted average common shares outstanding (C)

 

134,897

 

134,718

 

 

 

 

 

 

 

Basic net income per share (A/B)

 

$

0.12

 

$

0.25

 

Diluted net income per share (A/C)

 

$

0.12

 

$

0.24

 

 

5




During the three and six months ended June 30, 2006, approximately 13.8 million and 16.0 million options and warrants were excluded from the calculation of diluted EPS because the exercise prices plus the amount of compensation cost attributed to future services and not yet recognized exceeded the Company’s average stock price during the respective periods.

The Company has not included the effect of Common Stock Equivalents in the calculation of diluted EPS for the three and six months ended June 30, 2007 because such inclusion would have an anti-dilutive effect. As of June 30, 2007, the Company had 20.6 million options outstanding, 28.5 million warrants outstanding and 1.1 million restricted stock units outstanding. These options, warrants and restricted stock units could be dilutive in future periods. In addition, approximately 28.4 million shares underlie the Company’s convertible debt instruments, which could be dilutive in future periods.

5.  Investments

Investments in marketable securities

Investments in marketable securities are accounted for in accordance with SFAS No. 115, “Accounting for Certain Investments in Debt and Equity Securities.” All investments with original maturities greater than 90 days are classified as investments in marketable securities. Investments in marketable securities with maturities less than one year from the balance sheet date are considered short-term investments in marketable securities. Short-term investments also include investments in asset-backed, auction rate debt securities with interest rate reset periods of 90 days or less but whose underlying agreements have original maturities of more than 90 days, based on the provisions of Accounting Research Bulletin No. 43, Chapter 3A, Working Capital-Current Assets and Liabilities, which allows classification of investments based on management’s view. Investments in marketable securities with maturities greater than one year from the balance sheet date, excluding investments in asset-backed, auction rate debt securities with interest reset periods of 90 days or less, are considered long-term investments in marketable securities. The Company has invested in government agency notes, asset-backed debt securities (including auction rate debt securities), corporate notes and commercial paper, all of which bear a minimum short-term rating of A1/P1 or a minimum long-term rating of A/A2.

The Company has classified all short- and long-term investments in marketable securities as available-for-sale. The Company may or may not hold its investments in marketable securities until maturity. In response to changes in the availability of and the yield on alternative investments as well as liquidity requirements, the Company occasionally sells its investments in marketable securities prior to their stated maturities. Available for sale securities are carried at fair value, with any unrealized gains and losses, net of tax, included in unrealized gains (losses) on investments as a separate component of stockholders’ equity and in total comprehensive income (loss). As of December 31, 2006 and June 30, 2007, gross unrealized losses were $0.3 million and gross unrealized gains were nominal. The Company believes its gross unrealized losses are temporary because management has the intent and ability to hold these investments until maturity, at which time the Company would expect to receive the amortized cost basis of the investment based on the underlying contractual arrangement.

Realized gains and losses are included in interest income and other, net, in the accompanying Condensed Consolidated Statements of Operations and are determined on a specific identification basis. The Company has not realized any significant gains or losses on its investments in marketable securities during the periods presented.

Investments in other companies

As of December 31, 2006 and June 30, 2007, minority investments in other companies were $59.3 million and $55.1 million, respectively, and are classified as investments in other companies in the Condensed Consolidated Balance Sheets. The Company accounts for minority investments in other companies under the cost method of accounting and classifies investments in other companies which are publicly traded as available-for-sale securities. Accordingly, the Company adjusts the carrying values of those investments to market value through unrealized (losses) gains included in stockholders’ equity and accumulated other

6




comprehensive income (loss). Minority investments in other companies as of December 31, 2006 and June 30, 2007 included $11.0 million of investments carried at cost and $48.3 million and $44.1 million, respectively, of investments recorded at fair value. As of December 31, 2006 and June 30, 2007, gross unrealized losses were $6.5 million and $13.3 million, respectively, and there were no gross unrealized gains.

During the three months ended June 30, 2007, the Company received a $0.2 million cash distribution from eCompanies Venture Group, L.P. (“EVG”), a limited partnership that has invested in domestic emerging Internet-related companies, which was recorded as a gain on investments in other companies in the Condensed Consolidated Statements of Operations.

Management regularly evaluates the recoverability of its investments in other companies based on the performance and the financial position of those companies as well as other evidence of market value. Such evaluation includes, but is not limited to, reviewing the investee’s cash position, recent financings, projected and historical financial performance, cash flow forecasts and financing needs. Management also regularly evaluates whether declines in the fair values of its investments below their cost are potentially other than temporary. This evaluation consists of several qualitative and quantitative factors regarding the severity and duration of the unrealized loss as well as the Company’s ability and intent to hold the investment for a period of time which may be sufficient for an anticipated recovery in market value. During the three and six months ended June 30, 2006 and 2007, the Company did not recognize any losses due to other-than-temporary declines of the value of investments.

Investment in equity affiliate

The Company has a joint venture with SK Telecom Co., Ltd. (“SK Telecom”), HELIO. HELIO is a non-facilities-based mobile virtual network operator (“MVNO”) offering mobile communications services and handsets to U.S. consumers. As of December 31, 2006 and June 30, 2007, EarthLink’s and SK Telecom’s economic ownership interest in HELIO was approximately 48 percent, and EarthLink’s and SK Telecom’s voting interest was 50 percent.

Pursuant to the HELIO Contribution and Formation Agreement, the Company has contributed $220.0 million of cash and non-cash assets to date, including $122.0 million during 2005, $78.5 million during 2006 and $19.5 million during the six months ended June 30, 2007.

In July 2007, EarthLink and SK Telecom entered into a loan agreement with HELIO pursuant to which EarthLink and SK Telecom could lend up to $200.0 million to HELIO.  Under the terms of the agreement, EarthLink and SK Telecom may each purchase from HELIO up to $100.0 million of HELIO’s secured promissory notes (the “Promissory Notes”).  The Promissory Notes may be purchased by EarthLink and SK Telecom from time to time over a one year period commencing on the date of the agreement.  The Promissory Notes bear interest at 10.00% per annum, payable at maturity, and may be pre-paid by HELIO at any time without penalty.  The Promissory Notes mature on July 23, 2010, unless amounts become due and payable earlier by acceleration or otherwise.

In July 2007, EarthLink and SK Telecom purchased initial Promissory Notes of $30.0 million each.

The Company accounts for its investment in HELIO under the equity method of accounting because the Company can exert significant influence over HELIO’s operating and financial policies. As a result, the Company records its proportionate share of HELIO’s net loss in its Condensed Consolidated Statement of Operations. The Company is amortizing the difference between the book value and fair value of non-cash assets contributed to HELIO over their estimated useful lives. The amortization increases the carrying value of the Company’s investment and decreases the net losses of equity affiliate included in the Condensed Consolidated Statement of Operations. During the three and six months ended June 30, 2006, the Company recorded $15.4 million and $22.9 million, respectively, of net losses of equity affiliate related to its HELIO investment, which is net of amortization of basis differences and certain other equity method accounting adjustments. During the three and six months ended June 30, 2007, the Company recorded $40.1 million and $69.4 million, respectively, of net

7




losses of equity affiliate related to its HELIO investment, which is net of amortization of basis differences and certain other equity method accounting adjustments.

The following table presents summarized statement of operations information of HELIO for the three and six months ended June 30, 2006 and 2007:

 

Three Months Ended

 

Six Months Ended

 

 

 

June 30,

 

June 30,

 

 

 

2006

 

2007

 

2006

 

2007

 

 

 

(in thousands)

 

 

 

 

 

 

 

 

 

 

 

Revenues

 

$

5,712

 

$

33,185

 

$

11,192

 

$

63,544

 

Operating loss

 

(37,952

)

(84,971

)

(59,895

)

(150,085

)

Net loss

 

(35,468

)

(83,852

)

(55,377

)

(146,981

)

 

6.  Purchased Intangible Assets and Goodwill

Purchased Intangible Assets

The following table presents the components of the Company’s acquired identifiable intangible assets included in the accompanying Condensed Consolidated Balance Sheets as of December 31, 2006 and June 30, 2007:

 

 

As of December 31, 2006

 

As of June 30, 2007

 

 

 

Gross

 

 

 

Net

 

Gross

 

 

 

Net

 

 

 

Carrying

 

Accumulated

 

Carrying

 

Carrying

 

Accumulated

 

Carrying

 

 

 

Value

 

Amortization

 

Value

 

Value

 

Amortization

 

Value

 

 

 

(in thousands)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Subscriber bases and customer relationships

 

$

384,336

 

$

(337,708

)

$

46,628

 

$

387,659

 

$

(344,282

)

$

43,377

 

Software, technology and other

 

3,864

 

(1,551

)

2,313

 

3,864

 

(2,015

)

1,849

 

Trade names

 

10,857

 

 

10,857

 

10,857

 

 

10,857

 

Total

 

$

399,057

 

$

(339,259

)

$

59,798

 

$

402,380

 

$

(346,297

)

$

56,083

 

 

Amortization of intangible assets in the Condensed Consolidated Statements of Operations for the three and six months ended June 30, 2006 and 2007 represents the amortization of definite lived intangible assets.  The Company’s definite lived intangible assets primarily consist of subscriber bases and customer relationships, acquired software and technology and other assets acquired in conjunction with the purchases of businesses and subscriber bases from other companies that are not deemed to have indefinite lives. Definite lived intangible assets are amortized on a straight-line basis over their estimated useful lives, which are generally three to six years for subscriber bases and customer relationships and one to six years for acquired software and technology. As of December 31, 2006 and June 30, 2007, the weighted average amortization periods were 3.3 years for subscriber base assets and customer relationships and 4.1 years for software and technology. Based on the current amount of definite lived intangible assets, the Company expects to record amortization expense of approximately $8.9 million during the six months ending December 31, 2007 and $12.9 million, $10.0 million, $6.9 million, $6.3 million and $0.2 million during the years ending December 31, 2008, 2009, 2010, 2011 and thereafter, respectively. Actual amortization expense to be reported in future periods could differ materially from these estimates as a result of asset acquisitions, changes in useful lives and other relevant factors. The Company’s identifiable indefinite lived intangible assets consist of trade names.

8




7.  Long-Term Debt

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

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

As of December 31, 2006 and June 30, 2007, the fair value of the Notes was approximately $277.3 million and $277.9 million, respectively, based on quoted market prices.

In connection with the issuance of the Notes, the Company entered into separate convertible note hedge transactions and separate warrant transactions with respect to the Company’s common stock to reduce the potential dilution upon conversion of the Notes (collectively referred to as the “Call Spread Transactions”). The Company purchased call options to cover approximately 28.4 million shares of the Company’s common stock, subject to adjustment in certain circumstances, which is the number of shares underlying the Notes. In addition, the Company sold warrants permitting the purchasers to acquire up to approximately 28.4 million shares of the Company’s common stock, subject to adjustment in certain circumstances. See Note 8, “Stockholders’ Equity,” for more information on the Call Spread Transactions.

9




8.  Stockholders’ Equity

Comprehensive Income (Loss)

Comprehensive income (loss) includes unrealized gains and losses on certain investments classified as available-for-sale, net of tax, which are excluded from the Condensed Consolidated Statements of Operations in accordance with SFAS No. 130, “Reporting Comprehensive Income.” Comprehensive income (loss) for the three and six months ended June 30, 2006 and 2007 was as follows:

 

Three Months Ended

 

Six Months Ended

 

 

 

June 30,

 

June 30,

 

 

 

2006

 

2007

 

2006

 

2007

 

 

 

(in thousands)

 

Net income (loss)

 

$

16,567

 

$

(16,290

)

$

32,921

 

$

(46,252

)

Net unrealized gains (losses) on investments

 

3,139

 

(2,255

)

5,384

 

(6,798

)

Total comprehensive income (loss)

 

$

19,706

 

$

(18,545

)

$

38,305

 

$

(53,050

)

 

The net change in unrealized gains (losses) on investments for the three and six months ended June 30, 2006 and 2007 was primarily due to the change in estimated fair value of the Company’s investments in other companies as a result of changes in the closing prices of the common stock of these companies during the respective periods.

Share Repurchases

Since the inception of the Company’s share repurchase program, the Board of Directors has authorized a total of $550.0 million for the repurchase of EarthLink’s common stock. As of June 30, 2007, the Company had $95.3 million available under the current authorizations. The Company may repurchase its common stock from time to time in compliance with Securities and Exchange Commission regulations and other legal requirements, including through the use of derivative transactions, and subject to market conditions and other factors. The share repurchase program does not require the Company to acquire any specific number of shares and may be terminated by the Board of Directors at any time.

During the three and six months ended June 30, 2006, the Company purchased 2.3 million and 2.5 million shares, respectively, of its common stock for an aggregate purchase price of $19.5 million and $21.1 million, respectively. The Company did not repurchase any shares of its common stock during the three and six months ended June 30, 2007.

Call Spread Transactions

In connection with the issuance of the Notes (see Note 7, “Long-Term Debt”), the Company entered into separate convertible note hedge transactions and separate warrant transactions with respect to the Company’s common stock to minimize the impact of the potential dilution upon conversion of the Notes.  The Company purchased call options in private transactions to cover approximately 28.4 million shares of the Company’s common stock at a strike price of $9.12 per share, subject to adjustment in certain circumstances, for $47.2 million. The call options generally allow the Company to receive shares of the Company’s common stock from counterparties equal to the number of shares of common stock payable to the holders of the Notes upon conversion. These call options will terminate the earlier of the maturity dates of the related senior convertible notes or the first day all of the related senior convertible notes are no longer outstanding due to conversion or otherwise.  As of December 31, 2006 and June 30, 2007, the estimated fair value of the call options was $58.4 million and $60.0 million, respectively.

10




The Company also sold warrants permitting the purchasers to acquire up to approximately 28.4 million shares of the Company’s common stock at an exercise price of $11.20 per share, subject to adjustments in certain circumstances, in private transactions for total proceeds of approximately $32.1 million. The warrants expire at various dates in March 2012 through July 2012.  The warrants provide for net share settlement. In no event shall the Company be required to deliver a number of shares in connection with the transaction in excess of twice the aggregate number of warrants. As of December 31, 2006 and June 30, 2007, the estimated fair value of the warrants was $41.0 million and $42.8 million, respectively.

The Company has analyzed the Call Spread Transactions under EITF Issue No. 00-19, “Accounting for Derivative Financial Instruments Indexed to, and Potentially Settled In, a Company’s Own Stock,” and other relevant literature, and determined that they meet the criteria for classification as equity transactions. As a result, the Company recorded the purchase of the call options as a reduction in additional paid-in capital and the proceeds of the warrants as an increase to additional paid-in capital, and the Company does not recognize subsequent changes in fair value of the agreements in its financial statements.

9.  Stock-Based Compensation

The Company accounts for stock-based compensation pursuant to SFAS No. 123(R), “Share-Based Payment,” which requires measurement of 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 Company estimates the fair value of stock options using the Black-Scholes valuation model, and determines the fair value of restricted stock units based on the number of shares granted and the quoted price of EarthLink’s 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. The estimate of awards that will ultimately vest requires significant judgment, and to the extent actual results or updated estimates differ from the Company’s current estimates, such amounts will be recorded as a cumulative adjustment in the period estimates are revised. The Company considers 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 the Company’s current estimates.

Stock-based compensation expense under SFAS No. 123(R) was $3.7 million and $7.4 million during the three and six months ended June 30, 2006, respectively, and $2.9 million and $10.8 million during the three and six months ended June 30, 2007, respectively. The Company classifies stock-based compensation expense within the same operating expense line items as cash compensation paid to employees.

Included in stock-based compensation expense for the six months ended June 30, 2007 was $4.9 million of stock-based compensation expense related to Charles G. Betty, EarthLink’s former President and Chief Executive Officer. Mr. Betty passed away on January 2, 2007. Pursuant to Mr. Betty’s employment agreement, all unvested stock options and restricted stock units immediately vested and became fully exercisable upon death. In addition, the Leadership and Compensation Committee of the Board of Directors extended the exercise period of Mr. Betty’s stock options until December 31, 2008. This date represents the exercise period if Mr. Betty had terminated employment after serving the full term of his employment agreement, which was set to expire in July 2008. During the six months ended June 30, 2007, EarthLink recorded stock-based compensation of $3.5 million related to the accelerated vesting of 1.1 million stock options and 120,000 restricted stock units and recorded stock-based compensation expense of $1.4 million related to the extension of the exercise period for Mr. Betty’s stock options.

Stock Incentive Plans

The Company has granted options to employees and directors to purchase the Company’s common stock under various stock incentive plans. The Company has also granted restricted stock units to employees and directors under various stock incentive plans. Under the plans, employees and non-employee directors are eligible to receive awards of various forms of equity-based incentive compensation, including stock options, restricted stock, restricted stock units, phantom share units and performance awards, among others. The plans are

11




administered by the Board of Directors or the Leadership and Compensation Committee of the Board of Directors, which determine the terms of the awards granted. Stock options are generally granted with an exercise price equal to the market value of EarthLink, Inc. common stock on the date of grant, have a term of ten years or less, and vest over terms of four to six years from the date of grant. Restricted stock units generally vest over terms of three to four years from the date of grant.

Deferred Compensation Plan

The Company’s Second Deferred Compensation Plan for Directors and Certain Key Employees permits members of the Board of Directors and eligible employees to elect to defer receipt of shares of common stock pursuant to vested restricted stock units and various cash consideration, such as directors’ fees and bonuses. The cash consideration is converted into phantom share units at the closing price on the date the consideration would otherwise be paid, and vested restricted stock units are converted into phantom share units on a one-for-one basis. Phantom share units are fully vested at the date of grant and are converted to common stock upon the occurrence of various events. As of December 31, 2006 and June 30, 2007, approximately 29,000 and 32,000 phantom share units, respectively, were outstanding.

Warrants

Prior to December 31, 2000, the Company issued warrants to purchase shares of the Company’s common stock to certain members of its Board of Directors, customers, consultants, lessors, creditors and others. As of June 30, 2007, warrants to purchase a total of 52,000 shares of common stock were outstanding at an exercise price of $5.50. The warrants are currently exercisable and expire in October 2007.

During the year ended December 31, 2006, the Company sold warrants in connection with the issuance of Notes permitting the purchasers to acquire up to approximately 28.4 million shares of the Company’s common stock. See Note 8, “Shareholders’ Equity,” for a description of those warrants.

Options Outstanding

The following table summarizes information concerning stock option activity as of and for the six months ended June 30, 2007:

 

 

Stock Options

 

Weighted
Average
Exercise
Price

 

Weighted
Average
Remaining
Contractual
Term (Years)

 

Aggregate
Intrinsic
Value

 

 

 

(shares and dollars in thousands)

 

 

 

 

 

 

 

 

 

 

 

Outstanding as of December 31, 2006

 

20,470

 

$

11.27

 

 

 

 

 

Granted

 

2,156

 

7.36

 

 

 

 

 

Exercised

 

(663

)

7.79

 

 

 

 

 

Forfeited and expired

 

(1,408

)

11.64

 

 

 

 

 

Outstanding as of June 30, 2007

 

20,555

 

$

10.95

 

6.3

 

$

5,424

 

Vested and expected to vest as of June 30, 2007

 

18,995

 

$

11.17

 

6.1

 

$

4,554

 

Exercisable as of June 30, 2007

 

12,558

 

$

12.70

 

4.8

 

$

3,099

 

 

The aggregate intrinsic value amounts in the table above represent the closing price of the Company’s common stock on June 30, 2007 in excess of the exercise price, multiplied by the number of stock options outstanding or exercisable. The total intrinsic value of stock options exercised during the three and six months ended June 30, 2006 was $0.7 million and $1.8 million, respectively.  The total intrinsic value of stock options exercised during the three and six months ended June 30, 2007 was $0.4 million and $1.2 million, respectively.

12




The intrinsic value of stock options exercised represents the difference between the Company’s common stock at the time of exercise and the exercise price, multiplied by the number of stock options exercised.

The following table summarizes the status of the Company’s stock options as of June 30, 2007:

Stock Options Outstanding

 

Stock Options

 

 

 

 

 

 

 

Weighted

 

 

 

Exercisable

 

 

 

 

 

 

 

Average

 

Weighted

 

 

 

Weighted

 

 

 

 

 

 

 

Remaining

 

Average

 

 

 

Average

 

Range of

 

Number

 

Contractual

 

Exercise

 

Number

 

Exercise

 

Exercise Prices

 

Outstanding

 

Life

 

Price

 

Exercisable

 

Price

 

 

 

 

 

(in thousands)

 

 

 

 

 

(in thousands)

 

 

 

$

3.90

 

$

5.56

 

1,394

 

5.3

 

$

5.36

 

994

 

$

5.46

 

 

5.81

 

6.90

 

2,495

 

7.9

 

6.65

 

805

 

6.17

 

 

7.10

 

7.82

 

2,994

 

9.2

 

7.37

 

468

 

7.50

 

 

7.99

 

9.24

 

2,366

 

7.0

 

8.94

 

1,545

 

8.90

 

 

9.25

 

9.93

 

2,456

 

6.3

 

9.58

 

1,373

 

9.63

 

 

10.06

 

10.06

 

2,193

 

3.2

 

10.06

 

2,193

 

10.06

 

 

10.36

 

10.51

 

2,108

 

7.7

 

10.37

 

1,052

 

10.37

 

 

10.56

 

15.63

 

2,081

 

6.8

 

11.50

 

1,660

 

11.59

 

 

16.82

 

51.44

 

2,468

 

2.5

 

26.90

 

2,468

 

26.90

 

$

3.90

 

$

51.44

 

20,555

 

6.3

 

$

10.95

 

12,558

 

$

12.70

 

 

Valuation Assumptions for Stock Options

The fair value of stock options granted during the six months ended June 30, 2006 and 2007 was estimated using the Black-Scholes option-pricing model with the following assumptions:

 

Six Months Ended June 30,

 

 

 

2006

 

2007

 

 

 

 

 

 

 

Dividend yield

 

0

%

0

%

Expected volatility

 

43

%

39

%

Risk-free interest rate

 

4.86

%

4.88

%

Expected life

 

4.3 years

 

4.3 years

 

 

The weighted average grant date fair value of options granted during the six months ended June 30, 2006 and 2007 was $3.96 and $2.83, respectively.

The dividend yield assumption is based on the Company’s history and expectation of future dividend payouts. The expected volatility is based on a combination of the Company’s historical stock price and implied volatility. The selection of implied volatility data to estimate expected volatility is based upon the availability of prices for actively traded options on the Company’s stock. The risk-free interest rate assumption is based upon the U.S. Treasury yield in effect at the time of grant for periods corresponding with the expected life of the option. The expected life of employee stock options represents the weighted-average period the stock options are expected to remain outstanding.

13




Restricted Stock Units

The following table summarizes the Company’s restricted stock units as of and for the six months ended June 30, 2007:

 

 

Restricted
Stock Units

 

Weighted
Average
Grant Date
Fair Value

 

 

 

 

 

 

 

Nonvested as of December 31, 2006

 

1,180,000

 

$

8.57

 

Granted

 

147,000

 

7.40

 

Vested

 

(177,000

)

10.18

 

Forfeited

 

(60,000

)

8.50

 

Nonvested as of June 30, 2007

 

1,090,000

 

8.15

 

 

The fair value of restricted stock units is determined based on the closing trading price of EarthLink’s common stock on the grant date. The weighted-average grant date fair value of restricted stock units granted during the six months ended June 30, 2006 and 2007 was $9.44 and $7.40, respectively. As of June 30, 2007, there was $6.2 million of total unrecognized compensation cost related to nonvested restricted stock units. That cost is expected to be recognized over a weighted-average period of 3.0 years. The total fair value of shares vested during the six months ended June 30, 2007 was $1.3 million, which represents the closing price of the Company’s common stock on the vesting date multiplied by the number of restricted stock units that vested. No shares vested during the six months ended June 30, 2006.

10. Income Taxes

EarthLink has recorded income taxes for the three and six months ended June 30, 2007 based on management’s current expectations for the results of operations for the year ending December 31, 2007 in accordance with the interim reporting requirements of SFAS No. 109, “Accounting for Income Taxes,” and APB Opinion No. 28, “Interim Financial Reporting.”

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

11. Related Party Transactions

Upon HELIO’s formation, EarthLink and HELIO entered into a services agreement for EarthLink to provide to HELIO facilities, accounting, tax, billing, procurement, risk management, payroll, human resource, employee benefit administration and other support services in exchange for management fees. However, as HELIO has developed it business, the extent to which HELIO relies on EarthLink to provide these services has decreased. EarthLink believes that providing these services to HELIO enabled HELIO to more quickly and cost effectively launch its business than if it had purchased these services from third parties.  The management fees were determined based on EarthLink’s costs to provide the services, and management believes such fees are reasonable.  The total amount of fees that HELIO pays to EarthLink depends on the extent to which HELIO utilizes EarthLink’s services.  Fees for services provided to HELIO are reflected as reductions to the associated expenses incurred by EarthLink to provide such services. During the three and six months ended June 30, 2006, fees received for services provided to HELIO were $0.5 million and $1.2 million, respectively. During the three and six months ended June 30, 2007, fees received for services provided to HELIO were $0.5 million and $0.9 million, respectively.

14




EarthLink also markets HELIO’s products and services and purchases wireless Internet access devices and services from HELIO. During the three and six months ended June 30, 2006 and 2007, revenues generated from HELIO and fees paid for products and services from HELIO were nominal.

In July 2007, EarthLink entered into a loan agreement with HELIO pursuant to which EarthLink could lend up to $100.0 million to HELIO in the form of Promissory Notes (see Note 5, “Investments”). Also in July 2007, EarthLink purchased initial Promissory Notes of $30.0 million.

eCompanies

During the three months ended June 30, 2007, the Company received a $0.2 million cash distribution as a result of its investment in EVG. Sky Dayton, a member of EarthLink’s Board of Directors, is a founding partner in EVG .

12.  Segment Information

In accordance with SFAS No. 131, “Disclosures about Segments of an Enterprise and Related Information,” the Company reports segment information along the same lines that its chief executive reviews its operating results in assessing performance and allocating resources. Effective March 2007, the Company operates two reportable segments, Consumer Services and Business Services, which are described below in more detail.

The Company’s segments are strategic business units that are managed based upon differences in customers, services and marketing channels. The Company’s Consumer Services segment provides integrated communications services and related value-added services to individual customers. These services include dial-up and high-speed Internet access, municipal wireless broadband and voice services, among others. The Company’s Business Services segment provides integrated communications services and related value-added services to businesses and communications carriers. These services include managed data networks, dedicated Internet access and web hosting, among others.

The Company evaluates performance of its 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 costs over which segment managers have direct discretionary control, such as advertising and marketing programs, customer support expenses, site operations expenses, product development expenses, certain technology and facilities expenses, billing operations and 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 and stock-based compensation expense under SFAS No. 123(R), as they are not evaluated in the measurement of segment performance.

15




Information on reportable segments and a reconciliation to consolidated income from operations for the three and six months ended June 30, 2006 and 2007 is as follows:

 

Three Months Ended June 30,

 

Six Months Ended June 30,

 

 

 

2006

 

2007

 

2006

 

2007

 

 

 

(in thousands)

 

Consumer Services

 

 

 

 

 

 

 

 

 

Revenues

 

$

286,717

 

$

264,115

 

$

578,184

 

$

540,767

 

Cost of revenues

 

88,163

 

86,406

 

176,211

 

172,230

 

Gross margin

 

198,554

 

177,709

 

401,973

 

368,537

 

Direct segment operating expenses

 

156,877

 

141,258

 

331,448

 

306,983

 

Segment operating income

 

$

41,677

 

$

36,451

 

$

70,525

 

$

61,554

 

 

 

 

 

 

 

 

 

 

 

Business Services

 

 

 

 

 

 

 

 

 

Revenues

 

$

45,379

 

$

48,088

 

$

63,624

 

$

95,842

 

Cost of revenues

 

24,530

 

29,433

 

28,831

 

59,475

 

Gross margin

 

20,849

 

18,655

 

34,793

 

36,367

 

Direct segment operating expenses

 

14,830

 

16,118

 

17,421

 

32,787

 

Segment operating income

 

$

6,019

 

$

2,537

 

$

17,372

 

$

3,580

 

 

 

 

 

 

 

 

 

 

 

Consolidated

 

 

 

 

 

 

 

 

 

Revenues

 

$

332,096

 

$

312,203

 

$

641,808

 

$

636,609

 

Cost of revenues

 

112,693

 

115,839

 

205,042

 

231,705

 

Gross margin

 

219,403

 

196,364

 

436,766

 

404,904

 

Direct segment operating expenses

 

171,707

 

157,376

 

348,869

 

339,770

 

Segment operating income

 

47,696

 

38,988

 

87,897

 

65,134

 

Stock-based compensation expense

 

3,734

 

2,898

 

7,402

 

10,778

 

Amortization of intangible assets

 

3,122

 

3,542

 

5,035

 

7,038

 

Facility exit and restructuring costs

 

(117

)

 

(117

)

 

Other operating expenses

 

13,725

 

12,365

 

28,616

 

31,085

 

Income from operations

 

$

27,232

 

$

20,183

 

$

46,961

 

$

16,233

 

 

The primary component of the Company’s revenues is access and service revenues, which consist of narrowband access services (including traditional, fully-featured narrowband access and value-priced narrowband access); broadband access services (including high-speed access via DSL, cable and wireless technologies, IP-based voice and fees charged for high-speed data networks to small and medium-sized businesses); and web hosting services. The Company also earns revenues from value-added services, which include ancillary services sold as add-on features to the Company’s access services, search and advertising revenues.

Consumer access and service revenues consist of narrowband access, broadband access and voice services. These revenues are derived from monthly fees charged to customers for dial-up Internet access; monthly retail and wholesale fees charged for high-speed, high-capacity access services including DSL, cable and satellite; fees charged for IP-based voice services; usage fees; installation fees; termination fees; and fees for equipment. Consumer value-added services revenues consist of search revenues; advertising revenues; revenues from ancillary services sold as add-on features to the Company’s Internet services, such as security products, email by phone, Internet call waiting and email storage; and revenues from home networking products and services.

Business access and service revenues consist of retail and wholesale fees charged for high-speed, high-capacity access services including DSL, cable, satellite and dedicated circuit services; fees charged for high-speed

16




data networks for small and medium-sized businesses; installation fees; termination fees; fees for equipment; regulatory surcharges billed to customers; and web hosting.

Information on revenues by groups of similar services and by segment for the three and six months ended June 30, 2006 and 2007 is as follows:

 

Three Months Ended

 

Six Months Ended

 

 

 

June 30,

 

June 30,

 

 

 

2006

 

2007

 

2006

 

2007

 

 

 

(in thousands)

 

Consumer Services

 

 

 

 

 

 

 

 

 

Access and service

 

$

258,187

 

$

231,729

 

$

522,418

 

$

474,788

 

Value-added services

 

28,530

 

32,386

 

55,766

 

65,979

 

Total revenues

 

$

286,717

 

$

264,115

 

$

578,184

 

$

540,767

 

 

 

 

 

 

 

 

 

 

 

Business Services

 

 

 

 

 

 

 

 

 

Access and service

 

$

44,418

 

$

47,327

 

$

61,847

 

$

94,282

 

Value-added services

 

961

 

761

 

1,777

 

1,560

 

Total revenues

 

$

45,379

 

$

48,088

 

$

63,624

 

$

95,842

 

 

 

 

 

 

 

 

 

 

 

Consolidated

 

 

 

 

 

 

 

 

 

Access and service

 

$

302,605

 

$

279,056

 

$

584,265

 

$

569,070

 

Value-added services

 

29,491

 

33,147

 

57,543

 

67,539

 

Total revenues

 

$

332,096

 

$

312,203

 

$

641,808

 

$

636,609

 

 

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

The Company has not provided information about geographic segments because substantially all of the Company’s revenues and related results of operations and identifiable assets are in the United States and additional geographic information is thus not material nor meaningful.

17




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

Certain statements in this Quarterly Report on Form 10-Q 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 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 believes that its expectations are based on reasonable assumptions, it can give no assurance that its 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 “Safe Harbor Statement” in this Item 2.

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

Overview

EarthLink, Inc. is a total communications provider, providing integrated communication services and related value-added services to individual consumers and business customers utilizing Internet Protocol, or IP, based technologies.  Our core service offerings are dial-up and wireline broadband Internet access services and value-added services. Our growth initiatives have recently included IP-based voice services, municipal wireless broadband services and our services for business customers.

Effective March 2007, we operate as two reportable segments, Consumer Services and Business Services. Our Consumer Services segment provides integrated communications services and related value-added services to individual customers. These services include narrowband Internet access, wireline and wireless broadband Internet access and IP-based voice services. Our Business Services segment provides integrated communications services and related value-added services to businesses and communications carriers. These services include managed data networks, dedicated Internet access and web hosting.

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

Industry Background

Since the inception of our business, we have expanded from a traditional dial-up Internet service provider to a total communications provider. The Internet access market in the U.S. grew dramatically from the mid-1990s through 2000 but has recently experienced slower growth, as the market has reached a mature stage of growth. Since 2000, broadband Internet access has been steadily replacing dial-up. During 2006, the number of households with broadband access surpassed the number of households with dial-up access. Focused, value-priced narrowband access, which provides service with a limited set of features at a lower cost, is still attracting households new to the Internet or current Internet users interested in reducing their cost of Internet access.

Consumers continue to migrate to broadband 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, particularly for introductory promotional periods, services bundled with video and telephone services, and services with slower speeds, has been declining and is approaching prices for traditional dial-up services, making it a more viable option for consumers that continue to rely on dial-up connections for Internet access. In addition, advanced applications such as online gaming, music

18




downloads and photo sharing require greater bandwidth for optimal performance, which adds to the demand for broadband access.

Currently, most residential broadband consumers access the Internet via DSL or cable, but an increasing array of alternative broadband access technologies, such as wireless broadband and broadband over power lines, are now available. The availability of these alternatives may further encourage future broadband deployment and market penetration. The growth of mobile devices that support email and sales of laptop computers and other mobile devices create an increasing need for portable and mobile Internet access. In addition, one of the outgrowths from the rapid deployment of broadband connectivity has been the adoption of Voice over Internet Protocol (“VoIP”). VoIP is a technology that enables voice communications over the Internet through the conversion of voice signals into data packets. VoIP technology presents several advantages over the technology used in traditional wireline telephone networks and enables VoIP providers to operate with lower capital expenditures and operating costs while offering both traditional and innovative service features.

Revenue Sources

We provide access services (including traditional, fully-featured narrowband access and value-priced narrowband access; high-speed access via DSL, cable and wireless technologies; and IP-based voice) and value-added services (including ancillary services sold as add-on feature to our services, search and advertising). Our subscriber base decreased from approximately 5.3 million paying subscribers as of June 30, 2006 to approximately 4.3 million subscribers as of June 30, 2007. The decrease in paying subscribers was primarily due to the removal of approximately 753,000 subscribers that were under our marketing relationship with Embarq Corporation (“Embarq”) and a decrease in premium narrowband subscribers. Total revenues decreased from $332.1 million during the three months ended June 30, 2006 to $312.2 million during the three months ended June 30, 2007. The decrease in total revenues was primarily due to a decrease in narrowband access revenues, offset by an increases in IP-based voice services revenues and value-added services revenues. Our traditional, premium-priced narrowband subscriber base and revenues have been declining due to the maturity of this service. In addition, the mix of our narrowband customers continues to shift towards value-priced narrowband access.

Business Strategy and Risks

For the past several quarters, management has been focused on expanding our presence in growth markets, including VoIP services, municipal wireless broadband services and business services. VoIP and municipal wireless broadband services are still in their early stages and continue to experience operational and competitive challenges as we expand and improve our capabilities. Our ability to succeed in providing these new services will depend on whether we have a competitively-priced offering, improve the quality of these services and develop a reasonable cost structure to ensure an acceptable return on our investment. We are currently in the process of evaluating each of our growth initiatives in order to ensure these initiatives are complementary to our long-term strategy and would allow us to maximize shareholder value. Our evaluation of these growth initiatives could result in a substantial change to some or all of these growth initiatives.

Our recent business strategy has been to generate profits from our existing core access services and to reinvest the cash generated from these services into various growth initiatives with the objective of generating a return on our investments.

19




As we reassess our business strategy, we believe the most important factors for us to be successful are the following:

·                   identifying opportunities to improve the cost structure of our business without impacting the quality of services we provide;

·                   maximizing the return on our subscriber acquisition costs by balancing aggressive promotional pricing with the number of subscribers we are able to add and/or retain while continuing to reduce and leverage operating costs;

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

·                   monitoring the operations of our current growth initiatives, as well as our HELIO joint venture, to maximize the value to our shareholders and mitigate the risk of our investments;

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

·                   differentiating our products and services to enable us to deliver high quality services that improve customers’ Internet experiences, including bundling our various communications services; and

·                   exploring and evaluating potential strategic transactions that we believe may complement our current and future business activities, and successfully integrating any new acquisitions and investments into our business.

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

Second Quarter 2007 Highlights

As discussed above, total revenues decreased during the three months ended June 30, 2007 compared to the prior year period. However, overall operating expenses decreased during the three months ended June 30, 2007 compared to the prior period. This was mostly due to a decrease in sales and marketing expenses as we managed the expenses associated with our core access services to mitigate the increased spending for our growth initiatives. We continued to generate profits and operating cash flow from our core access services. Additionally, our net losses of equity affiliate related to our HELIO joint venture increased as HELIO incurred losses due to the start-up nature of their business. The decrease in total revenues and net losses of HELIO, offset by a decrease in total operating costs and expenses caused overall profits to decrease during the three months ended June 30, 2007 compared to the prior period.

Growth Initiatives

Our growth initiatives have recently included IP-based voice services, municipal wireless broadband services and services for business customers. We are currently in the process of evaluating each of our growth initiatives and, if necessary, changing the underlying business models and cost structures, in order to ensure these initiatives are complementary to our long-term strategy and would allow us to maximize shareholder value.

IP-based voice.  In October 2005, we began offering the next generation of our VoIP services, EarthLink trueVoice SM . EarthLink trueVoice is a competitive alternative to traditional telephone service and is available to EarthLink and non-EarthLink high-speed Internet access subscribers. In late 2005 and 2006, we launched DSL and Home Phone Service, a new DSL and VoIP service, which uses Covad Communications Group, Inc.’s (“Covad”) line-powered voice access that allows us to offer consumers low-cost phone services along with high-speed Internet access. In March 2006, we invested $50.0 million in Covad to fund the network build-out of this service. DSL and Home Phone Service is now available in 12 markets in the U.S. covering approximately 12.5 million households.

20




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

In March 2007, we purchased a municipal wireless network from the city of Corpus Christi, Texas that had already been deployed by the city. In June 2007, we transitioned the exiting network to our wireless network and began offering wireless Internet access to residents and businesses of Corpus Christi.

We currently have approximately 150 square miles of wireless broadband networks built out across all of our markets, covering 0.6 million households.

Business services . In April 2006, we acquired New Edge Holding Company (“New Edge”), a single-source national provider of secure multi-site managed data networks and dedicated Internet access for businesses and communications carriers. The acquisition of New Edge expands our service offerings to small and medium-sized enterprises. During 2006, we introduced new products, including Small Office DSL and hosted Virtual Private Networks (“VPN”). In 2007, we built upon our existing portfolio of business solutions, by expanding our product offerings and our distribution channels.

Joint Venture

We have a joint venture with SK Telecom, HELIO. HELIO is a non-facilities-based mobile virtual network operator (MVNO) offering mobile communications services and handsets to consumers in the U.S. As of June 30, 2007, EarthLink and SK Telecom each had an approximate 48% economic ownership interest and a 50% voting interest in HELIO.  From its formation in March 2005 though June 2007, EarthLink and SK Telecom invested an aggregate of $440.0 million of cash and non-cash assets in HELIO pursuant to the Contribution and Formation Agreement, including an aggregate of $39.0 million that was invested during the first six months of 2007.

In July 2007, we and SK Telecom entered into a lending agreement with HELIO pursuant to which we and SK Telecom could lend up to $200.0 million to HELIO. Under the terms of the agreement, we and SK Telecom may each lend HELIO up to $100.0 million in the form of promissory notes.  In July 2007, we and SK Telecom purchased initial promissory notes of $30.0 million each.

HELIO launched its first wireless voice and data service devices in during 2006, and launched its fifth exclusive device in the second quarter of 2007. HELIO targets young, connected consumers with an extensive array of features, including MySpace Mobile, video services, 3D and multiplayer games, and video, picture and text messaging, in addition to its wireless voice and data services.  HELIO is currently marketing its services through a variety of means.

21




Acquisition

In April 2006, we acquired New Edge. The acquisition of New Edge expands our service offerings for businesses and communications carriers. Under the terms of the merger agreement, we acquired 100% of New Edge in a merger transaction for 1.7 million shares of EarthLink common stock and $108.7 million in net cash, including cash to be used to satisfy certain New Edge liabilities and direct transaction costs. In July 2007, approximately 0.8 million shares of EarthLink, Inc. common stock that had been held in escrow were returned to us.

Marketing Alliances

We have an agreement with Time Warner Cable and Bright House Networks, companies whose networks pass more than 30 million homes, to offer our broadband Internet access services over their systems.  In connection with the agreement, Time Warner Cable and Bright House Networks receive consideration from EarthLink for carrying the EarthLink service and related Internet traffic. As of June 30, 2007, more than 40% of our consumer broadband subscribers were serviced via either the Time Warner Cable or Bright House Networks network.

We had a marketing relationship with Embarq, a spin-off of Sprint Nextel Corporation’s local communications business. The relationship provided that EarthLink was the wholesale high-speed ISP for Embarq’s local residential and small business customers. The contracts associated with these arrangements expired in April 2007, and we and Embarq did not renew the wholesale broadband contract. Effective April 2007, we removed approximately 753,000 subscribers under the marketing relationship from our broadband subscriber count and total subscriber count.

22




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:

 

June 30,

 

December 31,

 

March 31,

 

June 30,

 

 

 

2006

 

2006

 

2007

 

2007

 

Subscriber Data (a)

 

 

 

 

 

 

 

 

 

Consumer Services

 

 

 

 

 

 

 

 

 

Narrowband access subscribers

 

3,366,000

 

3,261,000

 

3,208,000

 

3,042,000

 

Broadband access subscribers

 

1,744,000

 

1,831,000

 

1,849,000

 

1,092,000

 

Total consumer services

 

5,110,000

 

5,092,000

 

5,057,000

 

4,134,000

 

Business Services

 

 

 

 

 

 

 

 

 

Narrowband access subscribers

 

46,000

 

40,000

 

36,000

 

31,000

 

Broadband access subscribers

 

69,000

 

69,000

 

69,000

 

70,000

 

Web hosting accounts

 

119,000

 

112,000

 

109,000

 

106,000

 

Total business services

 

234,000

 

221,000

 

214,000

 

207,000

 

Total subscriber count at end of period

 

5,344,000

 

5,313,000

 

5,271,000

 

4,341,000

 

 

 

Three Months Ended

 

Six Months Ended

 

 

 

June 30,

 

June 30,

 

 

 

2006

 

2007

 

2006

 

2007

 

Subscriber Activity

 

 

 

 

 

 

 

 

 

Subscribers at beginning of period

 

5,342,000

 

5,271,000

 

5,315,000

 

5,313,000

 

Gross organic subscriber additions

 

644,000

 

471,000

 

1,414,000

 

1,141,000

 

Acquired subscribers

 

70,000

 

34,000

 

70,000

 

34,000

 

Adjustment (b)

 

 

(753,000

)

 

(753,000

)

Churn

 

(712,000

)

(682,000

)

(1,455,000

)

(1,394,000

)

Subscribers at end of period

 

5,344,000

 

4,341,000

 

5,344,000

 

4,341,000

 

 

 

 

 

 

 

 

 

 

 

Churn rate (c)

 

4.4

%

4.9

%

4.5

%

4.7

%

 

 

 

 

 

 

 

 

 

 

Consumer Services Data

 

 

 

 

 

 

 

 

 

Average subscribers (d)

 

5,137,000

 

4,404,000

 

5,146,000

 

4,701,000

 

ARPU (e)

 

$

18.60

 

$

19.99

 

$

18.72

 

$

19.17

 

Churn rate (c)

 

4.5

%

5.0

%

4.6

%

4.8

%

 

 

 

 

 

 

 

 

 

 

Business Services Data

 

 

 

 

 

 

 

 

 

Average subscribers (d)

 

223,000

 

211,000

 

200,000

 

214,000

 

ARPU (e)

 

$

67.72

 

$

75.92

 

$

52.96

 

$

74.60

 

Churn rate (c)

 

2.9

%

2.7

%

2.9

%

2.7

%

 


(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) In April 2007, our wholesale contract with Embarq expired. As a result, we removed 753,000 EarthLink supported Embarq customers from our broadband subscriber count and total subscriber count.

23




(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 period by the average subscribers for the period. Churn rate for the three and six months ended June 30, 2007 excludes the impact of the Embarq adjustment.

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

(e) ARPU represents the average monthly revenue per user (subscriber). ARPU is computed by dividing average monthly revenue for the period by the average number of subscribers for the period. 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.

Results of Operations

Consolidated Results of Operations

The following table sets forth statement of operations data for the periods indicated:

 

 

Three Months Ended

 

 

 

 

 

Six Months Ended

 

 

 

 

 

 

 

June 30,

 

 

 

 

 

June 30,

 

 

 

 

 

 

 

2006

 

2007

 

$ Change

 

% Change

 

2006

 

2007

 

$ Change

 

% Change

 

 

 

(dollars in thousands)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Revenues

 

$

332,096

 

$

312,203

 

$

(19,893

)

-6

%

 

$

641,808

 

$

636,609

 

$

(5,199

)

-1

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Operating costs and expenses:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Service and equipment costs

 

110,301

 

110,472

 

171

 

0

%

 

200,373

 

221,630

 

21,257

 

11

%

 

Sales incentives

 

2,392

 

5,367

 

2,975

 

124

%

 

4,669

 

10,075

 

5,406

 

116

%

 

Total cost of revenues

 

112,693

 

115,839

 

3,146

 

3

%

 

205,042

 

231,705

 

26,663

 

13

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Sales and marketing

 

91,172

 

76,186

 

(14,986

)

-16

%

 

195,015

 

174,817

 

(20,198

)

-10

%

 

Operations and customer support

 

66,553

 

65,936

 

(617

)

-1

%

 

127,221

 

131,946

 

4,725

 

4

%

 

General and administrative

 

31,441

 

30,517

 

(924

)

-3

%

 

62,651

 

74,870

 

12,219

 

20

%

 

Amortization of intangible assets

 

3,122

 

3,542

 

420

 

13

%

 

5,035

 

7,038

 

2,003

 

40

%

 

Facility exit and restructuring costs

 

(117

)

 

117

 

-100

%

 

(117

)

 

117

 

-100

%

 

Total operating costs and expenses

 

304,864

 

292,020

 

(12,844

)

-4

%

 

594,847

 

620,376

 

25,529

 

4

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Income from operations

 

27,232

 

20,183

 

(7,049

)

-26

%

 

46,961

 

16,233

 

(30,728

)

-65

%

 

Net losses of equity affiliate

 

(15,351

)

(40,054

)

(24,703

)

*

 

 

(22,942

)

(69,400

)

(46,458

)

*

 

 

Gain on investments in other companies

 

352

 

210

 

(142

)

-40

%

 

352

 

210

 

(142

)

-40

%

 

Interest income and other, net

 

4,334

 

3,597

 

(737

)

-17

%

 

8,550

 

7,100

 

(1,450

)

-17

%

 

Income (loss) before income taxes

 

16,567

 

(16,064

)

(32,631

)

*

 

 

32,921

 

(45,857

)

(78,778

)

*

 

 

Provision for income taxes

 

 

226

 

226

 

*

 

 

 

395

 

395

 

*

 

 

Net income (loss)

 

$

16,567

 

$

(16,290

)

$

(32,857

)

*

 

 

$

32,921

 

$

(46,252

)

$

(79,173

)

*

 

 

 


* denotes percentage is not meaningful

24




Segment Results of Operations

Our business segments are strategic business units that are managed based upon differences in customers, services and marketing channels. Our Consumer Services segment provides dial-up Internet access, high-speed Internet access, municipal wireless broadband and voice services, among others, to individual customers. Our Business Services segment provides managed data networks, dedicated Internet access and web hosting, among others, to businesses and communications carriers.

We evaluate 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, site 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 and stock-based compensation expense under Statement of Financial Accounting Standards (“SFAS”) No. 123(R), as they are not evaluated in the measurement of segment performance.

The following tables set forth segment data for the periods indicated:

 

 

Three Months Ended June 30,

 

 

 

 

 

 

 

2006

 

2007

 

$ Change

 

% Change

 

 

 

(dollars in thousands)

 

Consumer Services

 

 

 

 

 

 

 

 

 

Revenues

 

$

286,717

 

$

264,115

 

$

(22,602

)

-8%

 

 

Cost of revenues

 

88,163

 

86,406

 

(1,757

)

-2%

 

 

Gross margin

 

198,554

 

177,709

 

(20,845

)

-10%

 

 

Direct segment operating expenses

 

156,877

 

141,258

 

(15,619

)

-10%

 

 

Segment income from operations

 

$

41,677

 

$

36,451

 

$

(5,226

)

-13%

 

 

 

 

 

 

 

 

 

 

 

 

 

Business Services

 

 

 

 

 

 

 

 

 

 

Revenues

 

$

45,379

 

$

48,088

 

$

2,709

 

6%

 

 

Cost of revenues

 

24,530

 

29,433

 

4,903

 

20%

 

 

Gross margin

 

20,849

 

18,655

 

(2,194

)

-11%

 

 

Direct segment operating expenses

 

14,830

 

16,118

 

1,288

 

9%

 

 

Segment income from operations

 

$

6,019

 

$

2,537

 

$

(3,482

)

-58%

 

 

 

 

 

 

 

 

 

 

 

 

 

Consolidated

 

 

 

 

 

 

 

 

 

 

Revenues

 

$

332,096

 

$

312,203

 

$

(19,893

)

-6%

 

 

Cost of revenues

 

112,693

 

115,839

 

3,146

 

3%

 

 

Gross margin

 

219,403

 

196,364

 

(23,039

)

-11%

 

 

Direct segment operating expenses

 

171,707

 

157,376

 

(14,331

)

-8%

 

 

Segment income from operations

 

47,696

 

38,988

 

(8,708

)

-18%

 

 

Stock-based compensation expense

 

3,734

 

2,898

 

(836

)

-22%

 

 

Amortization of intangible assets

 

3,122

 

3,542

 

420

 

13%

 

 

Facility exit and restructuring costs

 

(117

)

 

117

 

-100%

 

 

Other operating expenses

 

13,725

 

12,365

 

(1,360

)

-10%

 

 

Income from operations

 

$

27,232

 

$

20,183

 

$

(7,049

)

-26%

 

 

 

25




 

 

 

Six Months Ended June 30,

 

 

 

 

 

 

 

2006

 

2007

 

$ Change

 

% Change

 

 

 

(dollars in thousands)

 

Consumer Services

 

 

 

 

 

 

 

 

 

Revenues

 

$

578,184