EarthLink Holdings Corp.
EARTHLINK INC (Form: 10-Q, Received: 10/30/2009 16:51:34)

Table of Contents

 

 

 

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 September 30, 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

 

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 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 whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer x

 

Accelerated filer o

 

 

 

Non-accelerated filer o

 

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 o No x

 

As of October 29, 2009, 107,018,656 shares of common stock, $.01 par value per share, were outstanding.

 

 

 



Table of Contents

 

EARTHLINK, INC.

Quarterly Report on Form 10-Q

For the Quarterly Period Ended September 30, 2009

 

TABLE OF CONTENTS

 

Part I

 

 

Item 1. Financial Statements

1

 

 

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

24

 

 

Item 3. Quantitative and Qualitative Disclosures About Market Risk

47

 

 

Item 4. Controls and Procedures

47

 

 

Part II

 

 

Item 1. Legal Proceedings

47

 

 

Item 1A. Risk Factors

47

 

 

Item 5. Other Information

48

 

 

Item 6. Exhibits

48

 

 

Signatures

49

 



Table of Contents

 

PART I

 

Item 1.  Financial Statements.

 

EARTHLINK, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(in thousands, except per share data)

 

 

 

December 31,

 

September 30,

 

 

 

2008

 

2009

 

 

 

 

 

(unaudited)

 

ASSETS

 

Current assets:

 

 

 

 

 

Cash and cash equivalents

 

$

486,564

 

$

562,274

 

Accounts receivable, net of allowance of $4,048 and $1,920 as of December 31, 2008 and September 30, 2009, respectively

 

30,569

 

21,610

 

Marketable securities

 

 

90,791

 

Prepaid expenses

 

6,445

 

6,170

 

Deferred income taxes, net

 

20,254

 

4,543

 

Other current assets

 

15,452

 

17,201

 

Total current assets

 

559,284

 

702,589

 

Long-term marketable securities

 

47,809

 

1,807

 

Long-term investments

 

20,708

 

19,089

 

Property and equipment, net

 

37,246

 

34,759

 

Deferred income taxes, net

 

43,757

 

9,815

 

Purchased intangible assets, net

 

19,552

 

13,328

 

Goodwill

 

112,812

 

112,812

 

Other long-term assets

 

4,698

 

3,772

 

Total assets

 

$

845,866

 

$

897,971

 

 

 

 

 

 

 

LIABILITIES AND STOCKHOLDERS’ EQUITY

 

Current liabilities:

 

 

 

 

 

Accounts payable

 

$

13,109

 

$

8,061

 

Accrued payroll and related expenses

 

37,470

 

20,656

 

Other accrued liabilities

 

39,415

 

35,070

 

Deferred revenue

 

33,649

 

27,145

 

Convertible senior notes, net of discount of $29,743 as of September 30, 2009

 

 

229,007

 

Total current liabilities

 

123,643

 

319,939

 

 

 

 

 

 

 

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

 

219,733

 

 

Other long-term liabilities

 

16,015

 

16,492

 

Total liabilities

 

359,391

 

336,431

 

 

 

 

 

 

 

Stockholders’ equity:

 

 

 

 

 

Convertible preferred stock, $0.01 par value, 100,000 shares authorized, 0 shares issued and outstanding as of December 31, 2008 and September 30, 2009

 

 

 

Common stock, $0.01 par value, 300,000 shares authorized, 188,264 and 190,332 shares issued as of December 31, 2008 and September 30, 2009, respectively, and 108,516 and 106,992 shares outstanding as of December 31, 2008 and September 30, 2009, respectively

 

1,883

 

1,903

 

Additional paid-in capital

 

2,135,887

 

2,131,130

 

Accumulated deficit

 

(1,016,833

)

(922,984

)

Treasury stock, at cost, 79,748 and 83,340 shares as of December 31, 2008 and September 30, 2009, respectively

 

(634,420

)

(656,760

)

Unrealized (losses) gains on investments

 

(42

)

8,251

 

Total stockholders’ equity

 

486,475

 

561,540

 

Total liabilities and stockholders’ equity

 

$

845,866

 

$

897,971

 

 

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

 

1



Table of Contents

 

EARTHLINK, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

 

 

 

Three Months Ended September 30,

 

Nine Months Ended September 30,

 

 

 

2008

 

2009

 

2008

 

2009

 

 

 

(in thousands, except per share data)

 

 

 

(unaudited)

 

 

 

 

 

 

 

 

 

 

 

Revenues

 

$

230,831

 

$

174,521

 

$

739,508

 

$

559,181

 

 

 

 

 

 

 

 

 

 

 

Operating costs and expenses:

 

 

 

 

 

 

 

 

 

Cost of revenues

 

87,616

 

66,885

 

277,655

 

211,720

 

Sales and marketing

 

22,191

 

13,840

 

78,913

 

45,405

 

Operations and customer support

 

34,048

 

23,569

 

106,914

 

75,255

 

General and administrative

 

23,316

 

16,472

 

72,010

 

51,503

 

Amortization of intangible assets

 

3,153

 

2,039

 

11,153

 

6,224

 

Facility exit and restructuring costs

 

1,078

 

(97

)

4,169

 

5,318

 

Total operating costs and expenses

 

171,402

 

122,708

 

550,814

 

395,425

 

 

 

 

 

 

 

 

 

 

 

Income from operations

 

59,429

 

51,813

 

188,694

 

163,756

 

Gain on investments, net

 

4,352

 

35

 

5,677

 

305

 

Interest expense and other, net

 

(3,281

)

(5,067

)

(7,804

)

(14,458

)

Income from continuing operations before income taxes

 

60,500

 

46,781

 

186,567

 

149,603

 

Income tax provision

 

(7,924

)

(16,914

)

(23,923

)

(55,754

)

Income from continuing operations

 

52,576

 

29,867

 

162,644

 

93,849

 

Loss from discontinued operations

 

(681

)

 

(8,438

)

 

Net income

 

$

51,895

 

$

29,867

 

$

154,206

 

$

93,849

 

 

 

 

 

 

 

 

 

 

 

Basic net income per share

 

 

 

 

 

 

 

 

 

Continuing operations

 

$

0.48

 

$

0.28

 

$

1.48

 

$

0.88

 

Discontinued operations

 

(0.01

)

 

(0.08

)

 

Basic net income per share

 

$

0.47

 

$

0.28

 

$

1.40

 

$

0.88

 

Basic weighted average common shares outstanding

 

110,153

 

106,615

 

109,895

 

106,853

 

 

 

 

 

 

 

 

 

 

 

Diluted net income per share

 

 

 

 

 

 

 

 

 

Continuing operations

 

$

0.47

 

$

0.28

 

$

1.46

 

$

0.87

 

Discontinued operations

 

(0.01

)

 

(0.08

)

 

Diluted net income per share

 

$

0.46

 

$

0.28

 

$

1.38

 

$

0.87

 

Diluted weighted average common shares outstanding

 

112,039

 

107,943

 

111,534

 

108,052

 

 

 

 

 

 

 

 

 

 

 

Dividends declared per share

 

$

 

$

0.14

 

$

 

$

0.14

 

 

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

 

2



Table of Contents

 

EARTHLINK, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

 

 

 

Nine Months Ended

 

 

 

September 30,

 

 

 

2008

 

2009

 

 

 

(in thousands)

 

 

 

(unaudited)

 

Cash flows from operating activities:

 

 

 

 

 

Net income

 

$

154,206

 

$

93,849

 

Adjustments to reconcile net income to net cash provided by operating activities:

 

 

 

 

 

Depreciation and amortization

 

29,388

 

18,610

 

Loss on disposals and impairments of fixed assets

 

6,255

 

289

 

Stock-based compensation

 

14,319

 

10,552

 

Deferred income taxes

 

15,968

 

49,050

 

Accretion of debt discount and amortization of debt issuance costs

 

8,170

 

10,121

 

Gain on investments, net

 

(5,677

)

(305

)

Decrease in accounts receivable, net

 

13,269

 

8,959

 

(Increase) decrease in prepaid expenses and other assets

 

(6,466

)

4,466

 

Decrease in accounts payable and accrued and other liabilities

 

(45,491

)

(30,527

)

Decrease in deferred revenue

 

(9,364

)

(6,625

)

Net cash provided by operating activities

 

174,577

 

158,439

 

 

 

 

 

 

 

Cash flows from investing activities:

 

 

 

 

 

Purchases of property and equipment

 

(3,877

)

(10,648

)

Purchases of subscriber bases

 

(880

)

 

Purchases of marketable securities

 

(53,027

)

(52,502

)

Sales and maturities of marketable securities

 

109,929

 

12,473

 

Proceeds received from investments in other companies

 

57,070

 

200

 

Other investing activities

 

65

 

 

Net cash provided by (used in) investing activities

 

109,280

 

(50,477

)

 

 

 

 

 

 

Cash flows from financing activities:

 

 

 

 

 

Principal payments under capital lease obligations

 

(2,698

)

(25

)

Proceeds from exercises of stock options

 

7,985

 

5,073

 

Repurchases of common stock

 

(31,857

)

(22,340

)

Payment of dividends

 

 

(14,960

)

Other financing activities

 

1,425

 

 

Net cash used in financing activities

 

(25,145

)

(32,252

)

 

 

 

 

 

 

Net increase in cash and cash equivalents

 

258,712

 

75,710

 

Cash and cash equivalents, beginning of period

 

173,827

 

486,564

 

Cash and cash equivalents, end of period

 

$

432,539

 

$

562,274

 

 

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

 

3



Table of Contents

 

EARTHLINK, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

UNAUDITED

 

1.  Organization

 

EarthLink, Inc. (“EarthLink” or the “Company”) is an Internet service provider (“ISP”), providing nationwide Internet access and related value-added services to individual and business customers. The Company’s 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 the Company’s Internet access services, search and advertising. In addition, through the Company’s wholly-owned subsidiary, New Edge Networks (“New Edge”), the Company builds and manages private IP-based wide area networks for businesses and communications carriers.

 

The Company operates two reportable segments, Consumer Services and Business Services. The Company’s 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. The Company’s Business Services segment provides integrated communications services and related value-added services to businesses and communications carriers. These services include managed private IP-based wide area networks, dedicated Internet access and web hosting, among others. For further information concerning the Company’s business segments, see Note 13, “Segment Information.”

 

2.  Summary of Significant Accounting Policies

 

Basis of Presentation

 

The condensed consolidated financial statements of EarthLink, which include the accounts of its wholly-owned subsidiaries, for the three and nine months ended September 30, 2008 and 2009 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, 2008 contained in the Company’s Annual Report on Form 10-K as filed with the Securities and Exchange Commission (the “Annual Report”).  All significant intercompany transactions have been eliminated.  In connection with the preparation of the condensed consolidated financial statements the Company evaluated subsequent events after the balance sheet date of September 30, 2009 through October 30, 2009, the date of issuance of the Company’s condensed consolidated financial statements.

 

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 nine months ended September 30, 2009 are not necessarily indicative of the results anticipated for the entire year ending December 31, 2009.

 

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.

 

Discontinued Operations

 

The Company reflected its municipal wireless broadband results of operations as discontinued operations for the three and nine months ended September 30, 2008. See Note 5, “Discontinued Operations,” for further discussion.

 

4



Table of Contents

 

EARTHLINK, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

UNAUDITED - (Continued)

 

Fair Value of Financial Instruments

 

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

 

Reclassifications

 

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

 

Recently Issued Accounting Pronouncement

 

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. The Company does not expect the adoption of the new guidance to have a material impact on its financial statements.

 

Adoption of Recent Accounting Pronouncements

 

Codification . In the third quarter of 2009, the Company 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 the Company’s financial statements. However, the adoption of the ASC changed the Company’s references to GAAP in its consolidated financial statements.

 

Convertible Debt . On January 1, 2009, the Company adopted new accounting guidance related to accounting for convertible debt instruments that may be settled in cash upon conversion, which was codified in ASC Subtopic 470-20, “Debt With Conversion and Other Options.” 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 the Company’s Convertible Senior Notes due November 15, 2026 (the “Notes”), which were issued in November 2006. Upon adoption, the Company recorded an adjustment to increase additional paid-in capital as of the November 2006 issuance date by approximately $62.1 million. The Company is 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. The Company recorded a pre-tax adjustment of approximately $22.3 million to retained earnings that represents the debt discount accretion during the years ended December 31, 2006, 2007 and 2008 and will recognize additional non-cash interest expense of $12.2 million, $13.4 million and $12.4 million during the years ending December 31, 2009, 2010 and 2011, respectively, for accretion of the debt discount. As a result of the adoption of this new guidance, the Company reduced income from continuing operations and net income for the three months ended September 30, 2009 by $3.1 million and reduced basic and diluted earnings per share by $0.03 per share, and reduced income from continuing operations and net income for the nine months ended

 

5



Table of Contents

 

EARTHLINK, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

UNAUDITED - (Continued)

 

September 30, 2009 by $9.0 million and reduced basic and diluted earnings per share by $0.08 per share. The Company 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 the Company’s affected financial statement line items for the three and nine months ended September 30, 2008 and as of December 31, 2008:

 

 

 

Three Months Ended September 30, 2008

 

Nine Months Ended September 30, 2008

 

 

 

As Originally

 

As

 

Effect of

 

As Originally

 

As

 

Effect of

 

 

 

Reported

 

Adjusted

 

Change

 

Reported

 

Adjusted

 

Change

 

 

 

(in thousands, except per share data)

 

Statement of Operations:

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest (expense) income and other, net

 

$

(490

)

$

(3,281

)

$

(2,791

)

$

366

 

$

(7,804

)

$

(8,170

)

Income from continuing operations

 

55,367

 

52,576

 

(2,791

)

170,814

 

162,644

 

(8,170

)

Net income

 

54,686

 

51,895

 

(2,791

)

162,376

 

154,206

 

(8,170

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Basic net income per share

 

 

 

 

 

 

 

 

 

 

 

 

 

Continuing operations

 

$

0.50

 

$

0.48

 

$

(0.03

)

$

1.55

 

$

1.48

 

$

(0.07

)

Basic net income per share

 

0.50

 

0.47

 

(0.03

)

1.48

 

1.40

 

(0.07

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Diluted net income per share

 

 

 

 

 

 

 

 

 

 

 

 

 

Continuing operations

 

$

0.49

 

$

0.47

 

$

(0.02

)

$

1.53

 

$

1.46

 

$

(0.07

)

Diluted net income per share

 

0.49

 

0.46

 

(0.02

)

1.46

 

1.38

 

(0.07

)

 

 

 

As of December 31, 2008

 

 

 

As Originally

 

As

 

Effect of

 

 

 

Reported

 

Adjusted

 

Change

 

 

 

(in thousands)

 

Balance Sheet:

 

 

 

 

 

 

 

Other long-term assets

 

$

5,725

 

$

4,698

 

$

(1,027

)

Long-term debt

 

258,750

 

219,733

 

(39,017

)

Additional paid-in capital

 

2,075,571

 

2,135,887

 

60,316

 

Accumulated deficit

 

(994,507

)

(1,016,833

)

(22,326

)

 

3.  Earnings per Share

 

The Company presents 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, restricted stock units, phantom share units and convertible debt (collectively “Common Stock Equivalents”), were exercised or converted into common stock. The dilutive effect of outstanding stock options, restricted stock units and convertible debt is reflected in diluted earnings per share by application of the treasury stock method. Phantom share units are reflected on an if-converted basis. In applying the treasury stock method for stock-based compensation arrangements, the assumed proceeds are computed as the sum of the amount the employee must pay upon exercise and the amounts of average unrecognized compensation cost attributed to future services.

 

6



Table of Contents

 

EARTHLINK, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

UNAUDITED - (Continued)

 

The following table sets forth the computation for basic and diluted net income per share for the three and nine months ended September 30, 2008 and 2009:

 

 

 

Three Months Ended

 

Nine Months Ended

 

 

 

September 30,

 

September 30,

 

 

 

2008

 

2009

 

2008

 

2009

 

 

 

(in thousands, except per share data)

 

Numerator

 

 

 

 

 

 

 

 

 

Income from continuing operations

 

$

52,576

 

$

29,867

 

$

162,644

 

$

93,849

 

Loss from discontinued operations

 

(681

)

 

(8,438

)

 

Net income

 

$

51,895

 

$

29,867

 

$

154,206

 

$

93,849

 

 

 

 

 

 

 

 

 

 

 

Denominator

 

 

 

 

 

 

 

 

 

Basic weighted average common shares outstanding

 

110,153

 

106,615

 

109,895

 

106,853

 

Dilutive effect of Common Stock Equivalents

 

1,886

 

1,328

 

1,639

 

1,199

 

Diluted weighted average common shares outstanding

 

112,039

 

107,943

 

111,534

 

108,052

 

 

 

 

 

 

 

 

 

 

 

Basic net income per share

 

 

 

 

 

 

 

 

 

Continuing operations

 

$

0.48

 

$

0.28

 

$

1.48

 

$

0.88

 

Discontinued operations

 

(0.01

)

 

(0.08

)

 

Basic net income per share

 

$

0.47

 

$

0.28

 

$

1.40

 

$

0.88

 

 

 

 

 

 

 

 

 

 

 

Diluted net income per share

 

 

 

 

 

 

 

 

 

Continuing operations

 

$

0.47

 

$

0.28

 

$

1.46

 

$

0.87

 

Discontinued operations

 

(0.01

)

 

(0.08

)

 

Diluted net income per share

 

$

0.46

 

$

0.28

 

$

1.38

 

$

0.87

 

 

During the three months ended September 30, 2008 and 2009, approximately 8.0 million and 4.1 million, respectively, stock options and restricted stock units were excluded from the calculation of diluted EPS because the exercise prices plus the amount of unrecognized compensation cost attributed to future services exceeded the Company’s average stock price during the respective periods. During the nine months ended September 30, 2008 and 2009, approximately 8.7 million and 5.2 million, respectively, stock options and restricted stock units were excluded from the calculations of diluted EPS. Approximately 28.4 million and 28.9 million shares as of September 30, 2008 and 2009, respectively, that underlie the Company’s convertible debt instruments were also excluded from the calculations of diluted EPS because the exercise price exceeded the Company’s average stock price during the periods. These securities could be dilutive in future periods.

 

7



Table of Contents

 

EARTHLINK, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

UNAUDITED - (Continued)

 

4.  Facility Exit and Restructuring Costs

 

Facility exit and restructuring costs consisted of the following during the three and nine months ended September 30, 2008 and 2009:

 

 

 

Three Months Ended

 

Nine Months Ended

 

 

 

September 30,

 

September 30,

 

 

 

2008

 

2009

 

2008

 

2009

 

 

 

(in thousands)

 

 

 

 

 

 

 

 

 

 

 

2007 Restructuring Plan

 

$

1,159

 

$

31

 

$

4,421

 

$

5,446

 

Legacy Restructuring Plans

 

(81

)

(128

)

(252

)

(128

)

 

 

$

1,078

 

$

(97

)

$

4,169

 

$

5,318

 

 

2007 Restructuring Plan

 

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

 

The Company recorded $5.4 million of facility exit and restructuring costs during the nine months ended September 30, 2009 as a result of changes to sublease estimates in its Atlanta, Georgia and Pasadena, California facilities and further consolidation in its Atlanta, GA facility. The following table summarizes facility exit and restructuring costs during the nine months ended September 30, 2008 and 2009 and the cumulative costs incurred to date as a result of the 2007 Plan. Such costs have been classified as facility exit and restructuring costs in the Condensed Consolidated Statements of Operations.

 

 

 

 

 

 

 

Cumulative

 

 

 

 

 

 

 

Costs

 

 

 

Nine Months Ended September 30,

 

Incurred

 

 

 

2008

 

2009

 

To Date

 

 

 

(in thousands)

 

 

 

 

 

 

 

 

 

Severance and personnel-related costs

 

$

474

 

$

 

$

30,764

 

Lease termination and facilities-related costs

 

3,352

 

5,400

 

22,424

 

Non-cash asset impairments

 

514

 

46

 

24,792

 

Other associated costs

 

81

 

 

1,131

 

 

 

$

4,421

 

$

5,446

 

$

79,111

 

 

8



Table of Contents

 

EARTHLINK, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

UNAUDITED - (Continued)

 

The following table summarizes activity for the liability balances associated with the 2007 Plan for the years ended December 31, 2007 and 2008 and for the nine months ended September 30, 2009, including changes during the years attributable to costs incurred and charged to expense and costs paid or otherwise settled:

 

 

 

Severance

 

 

 

Asset

 

Other

 

 

 

 

 

and Benefits

 

Facilities

 

Impairments

 

Costs

 

Total

 

 

 

(in thousands)

 

Balance as of December 31, 2006

 

$

 

$

 

$

 

$

 

$

 

Accruals

 

30,303

 

12,216

 

20,621

 

1,131

 

64,271

 

Payments

 

(18,262

)

(480

)

 

(760

)

(19,502

)

Non-cash charges

 

 

4,388

 

(20,621

)

(371

)

(16,604

)

Balance as of December 31, 2007

 

12,041

 

16,124

 

 

 

28,165

 

Accruals

 

461

 

4,808

 

4,125

 

 

9,394

 

Payments

 

(12,502

)

(6,174

)

 

 

(18,676

)

Non-cash charges

 

 

1,936

 

(4,125

)

 

(2,189

)

Balance as of December 31, 2008

 

 

16,694

 

 

 

16,694

 

Accruals

 

 

5,400

 

46

 

 

5,446

 

Payments

 

 

(3,732

)

 

 

(3,732

)

Non-cash charges

 

 

392

 

(46

)

 

346

 

Balance as of September 30, 2009

 

$

 

$

18,754

 

$

 

$

 

$

18,754

 

 

Facility exit and restructuring liabilities due within one year of the balance sheet date are classified as other accrued liabilities and facility exit and restructuring liabilities due after one year of the balance sheet date are classified as other long-term liabilities in the Condensed Consolidated Balance Sheets. Of the unpaid balance as of December 31, 2008 and September 30, 2009, approximately $5.9 million and $5.8 million, respectively, were classified as other accrued liabilities and approximately $10.8 million and $13.0 million, respectively, were classified as other long-term liabilities.

 

Legacy Restructuring Plans

 

During the years ended December 31, 2003, 2004 and 2005, the Company executed a series of plans to restructure and streamline the Company’s 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. EarthLink periodically evaluates and adjusts its estimates for facility exit and restructuring costs based on currently-available information. Such adjustments are included as facility exit and restructuring costs in the Condensed Consolidated Statements of Operations. During the three and nine months ended September 30, 2008, EarthLink recorded a $0.1 million and $0.3 million reduction, respectively, to facility exit and restructuring costs as a result of changes in estimates for the Legacy Plans. During the three and nine months ended September 30, 2009, EarthLink recorded a $0.1 million reduction to facility exit and restructuring costs as a result of changes in estimates for the Legacy Plans. As of September 30, 2009, the Company had a $0.7 million liability remaining for real estate commitments related to the Legacy Plans which was classified as other accrued liabilities in the Condensed Consolidated Balance Sheet. All other costs have been paid.

 

9



Table of Contents

 

EARTHLINK, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

UNAUDITED - (Continued)

 

5.  Discontinued Operations

 

In November 2007, management concluded that its municipal wireless broadband operations were no longer consistent with the Company’s strategic direction and the Company’s Board of Directors authorized management to pursue the divestiture of the Company’s municipal wireless broadband assets. As a result of that decision, the Company classified the municipal wireless broadband assets as held for sale and presented the municipal wireless broadband results of operations as discontinued operations. The results of operations for municipal wireless broadband were previously included in the Consumer Services segment.  As of December 31, 2008, the Company had completed the divestiture of its municipal wireless broadband assets. As a result, the Company did not record discontinued operations during the three and nine months ended September 30, 2009.

 

The following table presents summarized results of operations related to the Company’s discontinued operations for the three and nine months ended September 30, 2008:

 

 

 

Three Months Ended

 

Nine Months Ended

 

 

 

September 30, 2008

 

September 30, 2008

 

 

 

(in thousands)

 

 

 

 

 

 

 

Revenues

 

$

18

 

$

1,306

 

Operating costs and expenses

 

(842

)

(4,534

)

Impairment and restructuring costs

 

(128

)

(6,081

)

Income tax benefit

 

271

 

871

 

Loss from discontinued operations

 

$

(681

)

$

(8,438

)

 

6.  Investments

 

Marketable Securities

 

All investments with original maturities greater than 90 days are classified as marketable securities. Marketable securities with maturities less than one year from the balance sheet date are classified as short-term marketable securities. Marketable securities with maturities greater than one year from the balance sheet date are classified as long-term marketable securities. Long-term marketable securities as of December 31, 2008 also included investments in asset-backed, auction rate securities with interest rate reset periods of 90 days or less but whose underlying agreements have original maturities of more than 90 days. These securities were classified as short-term marketable securities as of September 30, 2009, which is more fully described below.

 

As of December 31, 2008, the Company’s long term marketable securities consisted of auction rate securities classified as trading with a carrying value and fair value of $47.8 million. As of September 30, 2009, the Company had $90.8 million of short-term marketable securities and $1.8 million of long-term marketable securities. As of September 30, 2009, $47.8 million of the Company’s short-term marketable securities and the $1.8 million of the Company’s long-term marketable securities consisted of government agency notes and were classified as available-for-sale. The amortized cost for these securities was $49.5 million and the aggregate fair value was $49.6 million. Gross unrealized gains on these securities as of September 30, 2009 were $0.1 million and there were no gross unrealized losses. As of September 30, 2009, $43.0 million of the Company’s short-term marketable securities consisted of auction rate securities which were classified as trading. 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 the Company continuing to hold such securities. Accordingly, the Company classified these securities as long-term marketable securities in the Condensed Consolidated Balance Sheet as of December 31, 2008 due to uncertainty surrounding the timing of a market recovery.

 

10



Table of Contents

 

EARTHLINK, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

UNAUDITED - (Continued)

 

In October 2008, EarthLink entered into an agreement with the broker that sold the Company its auction rate securities that gives the Company the right to sell its 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”). Accordingly, the Company classified its auction rate securities as short-term marketable securities in the Condensed Consolidated Balance Sheet as of September 30, 2009. The agreement also grants the broker the right to buy the Company’s auction rate securities at par plus accrued interest, until July 2, 2012. The Company records the auction rate securities at fair value, with changes in fair value included in earnings, as the Company no longer intends to hold the securities until a market recovery. The Company also elected a one-time transfer of its auction rate securities from the available-for-sale category to the trading category. The Company also records the value of the put right at fair value, with changes in fair value included in earnings, as the Company elected the fair value option under ASC 825, “Financial Instruments,” for the put right to offset the fair value changes of the auction rate securities. During the nine months ended September 30, 2009, the Company redeemed $9.5 million of auction rate securities at par, plus accrued interest. During the nine months ended September 30, 2009, the Company recorded a $4.7 million gain on investments related to the auction rate securities and recorded a $4.6 million loss on investments related to the put right. The net gain of $0.1 million during the nine months ended September 30, 2009 is included in gain on investments, net, in the Condensed Consolidated Statement of Operations. The net gain during the three months ended September 30, 2009 was nominal. Refer to Note 12, “Fair Value Measurements,” for a table that reconciles the beginning and ending balances of the auction rate securities.

 

Investments

 

Long-term investments consisted of the following as of December 31, 2008 and September 30, 2009:

 

 

 

As of

 

As of

 

 

 

December 31,

 

September 30,

 

 

 

2008

 

2009

 

 

 

(in thousands)

 

Investments stated at fair value

 

$

11,408

 

$

9,789

 

Investments stated at cost

 

9,300

 

9,300

 

Total long-term investments

 

$

20,708

 

$

19,089

 

 

Long-term investments in the Condensed Consolidated Balance Sheets include investments in other companies. Investments in other companies are accounted for under the cost method of accounting because the Company does not have the ability to exercise significant influence over the companies’ operations. Under the cost method of accounting, investments in private companies are carried at cost and are only adjusted for other-than-temporary declines in fair value and distributions of earnings. For cost method investments in public companies that have readily determinable fair values, the Company classifies its investments as available-for-sale and, accordingly, records these investments at their fair values with unrealized gains and losses included as a separate component of stockholders’ equity and in total comprehensive income. As of September 30, 2009, gross unrealized gains on available-for-sale investments were $8.2 million and there were no gross unrealized losses.  As of December 31, 2008, gross unrealized losses on available-for-sale investments were nominal and there were no gross unrealized gains.

 

Long-term investments in the Condensed Consolidated Balance Sheet as of December 31, 2008 also included the Company’s put right. The Company has a put right to sell its existing auction rate securities back to the broker beginning on June 30, 2010, which had a carrying value and fair value of $9.8 million and $5.3 million as of December 31, 2008 and September 30, 2009, respectively. The Company classified the put right as other current assets in the Condensed Consolidated Balance Sheet as of September 30, 2009. The Company elected the fair value option under ASC 825 for the put right and records the put right at fair value, with changes in fair value recognized as gain on investments, net in the Condensed Consolidated Statement of Operations. The fair value of the put right is estimated using a discounted cash flow analysis.

 

11



Table of Contents

 

EARTHLINK, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

UNAUDITED - (Continued)

 

Management regularly evaluates the recoverability of its investments 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 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 to recover the cost basis of the investment.

 

During the nine months ended September 30, 2008, the Company recognized a net gain on investments of $5.7 million. This consisted of a gain of $4.4 million from the sale of HELIO to Virgin Mobile USA, Inc. and a gain of $2.0 million from the sale of the Company’s 6.1 million shares of Covad Communications Group, LLC common stock to Platinum Equity, LLC, offset by an impairment loss of $0.7 million due to other-than-temporary declines of the value of certain long-term investments. During the nine months ended September 30, 2009, the Company recognized a net gain on investments of $0.3 million. This consisted of $0.2 million in cash distributions from eCompanies Venture Group, L.P., a limited partnership that invested in domestic emerging Internet-related companies, and a net gain of $0.1 million related to the Company’s auction rate securities and put right.

 

7.  Purchased Intangible Assets and Goodwill

 

Goodwill

 

There were no changes in the carrying amount of goodwill during the nine months ended September 30, 2009.

 

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, 2008 and September 30, 2009:

 

 

 

As of December 31, 2008

 

As of September 30, 2009

 

 

 

Gross

 

 

 

Net

 

Gross

 

 

 

Net

 

 

 

Carrying

 

Accumulated

 

Carrying

 

Carrying

 

Accumulated

 

Carrying

 

 

 

Value

 

Amortization

 

Value

 

Value

 

Amortization

 

Value

 

 

 

(in thousands)

 

Intangible assets subject to amortization:

 

 

 

 

 

 

 

 

 

 

 

 

 

Subscriber bases and customer relationships

 

$

94,039

 

$

(77,758

)

$

16,281

 

$

94,039

 

$

(83,664

)

$

10,375

 

Software, technology and other

 

739

 

(649

)

90

 

711

 

(711

)

 

Trade names

 

1,521

 

(304

)

1,217

 

1,521

 

(532

)

989

 

 

 

96,299

 

(78,711

)

17,588

 

96,271

 

(84,907

)

11,364

 

Intangible assets not subject to amortization:

 

 

 

 

 

 

 

 

 

 

 

 

 

Trade names

 

1,964

 

 

1,964

 

1,964

 

 

1,964

 

 

 

$

 98,263

 

$

(78,711

)

$

19,552

 

$

98,235

 

$

(84,907

)

$

13,328

 

 

Amortization of intangible assets in the Condensed Consolidated Statements of Operations for the three and nine months ended September 30, 2008 and 2009 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, trade names 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. The Company’s identifiable indefinite-lived intangible assets consist of certain trade names. Definite-lived

 

12



Table of Contents

 

EARTHLINK, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

UNAUDITED - (Continued)

 

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 three years for acquired software and technology.  As of September 30, 2009, the weighted average amortization periods were 4.2 years for subscriber base assets and customer relationships, 3.0 years for software and technology and 5.0 years for trade names. Based on the current amount of definite-lived intangible assets, the Company expects to record amortization expense of approximately $1.5 million during the remaining three months in the year ending December 31, 2009 and $4.1 million, $2.9 million, $1.5 million, $0.8 million and $0.6 million during the years ending December 31, 2010, 2011, 2012, 2013 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.

 

8.  Convertible Senior Notes

 

General

 

In November 2006, the Company issued $258.8 million aggregate principal amount of the Notes in a registered offering. 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, are convertible into shares of the Company’s common stock. The initial conversion rate was 109.6491 shares per $1,000 principal amount of Notes (which represented an initial conversion price of approximately $9.12 per share). As a result of the Company’s cash dividend payment in September 2009, the conversion rate was adjusted and is 111.5096 shares per $1,000 principal amount of Notes (which represents a conversion price of approximately $8.97 per share), subject to further adjustment. 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, including the payment of dividends in certain circumstances; (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 has 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.

 

Adoption of New Accounting Guidance

 

On January 1, 2009, the Company adopted new accounting guidance related to accounting for convertible debt instruments that may be settled in cash upon conversion, which 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. The adoption of the new guidance on January 1, 2009 affected the

 

13



Table of Contents

 

EARTHLINK, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

UNAUDITED - (Continued)

 

Company’s accounting for the Notes. Upon adoption, the Company recorded an adjustment to increase additional paid-in capital as of the November 2006 issuance date by approximately $62.1 million. The Company is 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. The Company recorded a pre-tax adjustment of approximately $22.3 million to retained earnings that represents the debt discount accretion during the years ended December 31, 2006, 2007 and 2008 and will recognize additional non-cash interest expense of $12.2 million, $13.4 million and $12.4 million during the years ending December 31, 2009, 2010 and 2011, respectively, for accretion of the debt discount.

 

As of December 31, 2008, the principal amount of the Notes, the unamortized discount and the net carrying value was $258.8 million, $39.0 million and $219.7 million, respectively. As of September 30, 2009, the principal amount of the Notes, the unamortized discount and the net carrying value was $258.8 million, $29.7 million and $229.0 million, respectively. As of December 31, 2008 and September 30, 2009, the fair value of the Notes was approximately $236.6 million and $284.9 million, respectively, based on the quoted market prices.

 

Classification

 

In July 2009 and October 2009, the Company’s Board of Directors declared quarterly cash dividends on its common stock. The Company currently intends to pay regular quarterly dividends on its common stock.  Under the terms of the indenture governing the Notes, the Company’s payment of cash dividends requires an adjustment to the conversion rate for the Notes. In addition, 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. As a result, the Company classified the Notes as a current liability in the Condensed Consolidated Balance Sheet as of September 30, 2009. The Notes were classified as long-term debt in the Condensed Consolidated Balance Sheet as of December 31, 2008.

 

14



Table of Contents

 

EARTHLINK, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

UNAUDITED - (Continued)

 

9.  Stockholders’ Equity

 

Comprehensive Income

 

Comprehensive income 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. Comprehensive income for the three and nine months ended September 30, 2008 and 2009 was as follows:

 

 

 

Three Months Ended

 

Nine Months Ended

 

 

 

September 30,

 

September 30,

 

 

 

2008

 

2009

 

2008

 

2009

 

 

 

(in thousands)

 

Net income

 

$

51,895

 

$

29,867

 

$

154,206

 

$

93,849

 

Unrealized holding (losses) gains on certain investments

 

(1,190

)

1,877

 

(2,214

)

8,293

 

Reclassification adjustment for realized gains on certain investments

 

 

 

(1,779

)

 

Total comprehensive income

 

$

50,705

 

$

31,744

 

$

150,213

 

$

102,142

 

 

Share Repurchases

 

Since the inception of the Company’s share repurchase program, the Board of Directors has authorized a total of $750.0 million for the repurchase of EarthLink’s common stock. As of September 30, 2009, the Company had $146.8 million available under the current authorization. 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.

 

The Company repurchased 1.3 million shares of its common stock for $9.1 million during the nine months ended September 30, 2008. The Company repurchased 3.6 million shares of its common stock for $22.3 million during the nine months ended September 30, 2009.

 

Dividends

 

In July 2009, the Company’s Board of Directors declared a quarterly cash dividend on its common stock of $0.14 per share to stockholders of record on September 14, 2009.  The dividend was paid on September 28, 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 be paid on December 23, 2009 to stockholders of record on December 9, 2009. The Company currently intends to pay regular quarterly dividends on its common stock.  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. Any decision to declare future dividends will be made at the discretion of the Board of Directors and will depend on, among other things, the Company’s results of operations, financial condition, cash requirements, investment opportunities and other factors the Board of Directors may deem relevant.

 

15



Table of Contents

 

EARTHLINK, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

UNAUDITED - (Continued)

 

10.  Stock-Based Compensation

 

The Company measures compensation cost for all stock awards at fair value on the date of grant and recognition of compensation expense 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. For performance-based awards, the Company recognizes 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 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 was $4.6 million and $3.1 million during the three months ended September 30, 2008 and 2009, respectively, and $14.3 million and $10.6 million during the nine months ended September 30, 2008 and 2009, respectively.  The Company has classified stock-based compensation expense during the three and nine months ended September 30, 2008 and 2009 within the same operating expense line items as cash compensation paid to employees.

 

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 and performance awards, among others. The plans are 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 the Company’s common stock on the date of grant, have a term of ten years or less, and vest over terms of four to nine years from the date of grant. Restricted stock units are granted with various vesting terms that range from one to nine years from the date of grant.

 

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Table of Contents

 

EARTHLINK, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

UNAUDITED - (Continued)

 

Options Outstanding

 

The following table summarizes information concerning stock option activity as of and for the nine months ended September 30, 2009:

 

 

 

 

 

 

 

Weighted

 

 

 

 

 

 

 

Weighted

 

Average

 

 

 

 

 

 

 

Average

 

Remaining

 

Aggregate

 

 

 

 

 

Exercise

 

Contractual

 

Intrinsic

 

 

 

Stock Options

 

Price

 

Term (Years)

 

Value

 

 

 

(shares and dollars in thousands)

 

 

 

 

 

 

 

 

 

 

 

Outstanding as of December 31, 2008

 

7,159

 

$

9.58

 

 

 

 

 

Granted

 

 

 

 

 

 

 

Exercised

 

(1,917

)

6.92

 

 

 

 

 

Forfeited and expired

 

(998

)

13.61

 

 

 

 

 

Outstanding as of September 30, 2009

 

4,244

 

9.83

 

4.8

 

$

1,950

 

Vested and expected to vest as of September 30, 2009

 

4,072

 

$

9.94

 

4.7

 

$

1,748

 

Exercisable as of September 30, 2009

 

3,269

 

$

10.48

 

4.1

 

$

991

 

 

The aggregate intrinsic value amounts in the table above represent the closing price of the Company’s common stock on September 30, 2009 in excess of the exercise price, multiplied by the number of stock options outstanding or exercisable, when the closing price is greater than the exercise price. This represents the amount that would have been received by the stock option holders if they had all exercised their stock options on September 30, 2009. The total intrinsic value of options exercised during the three and nine months ended September 30, 2008 was $0.7 million and $2.2 million, respectively. The total intrinsic value of options exercised during the three and nine months ended September 30, 2009 was $2.2 million and $2.5 million, respectively. The intrinsic value of stock options exercised represents the difference between the closing price of the Company’s common stock at the time of exercise and the exercise price, multiplied by the number of stock options exercised. To the extent the forfeiture rate is different than what the Company has anticipated, stock-based compensation related to these awards will be different from the Company’s expectations.

 

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Table of Contents

 

EARTHLINK, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

UNAUDITED - (Continued)

 

The following table summarizes the status of the Company’s stock options as of September 30, 2009:

 

 

 

 

 

 

 

 

 

 

 

Stock Options

 

Stock Options Outstanding

 

Exercisable

 

 

 

 

 

 

 

Weighted

 

 

 

 

 

 

 

 

 

 

 

 

 

Average

 

Weighted

 

 

 

Weighted

 

 

 

 

 

 

 

Remaining

 

Average

 

 

 

Average

 

Range of

 

Number

 

Contractual

 

Exercise

 

Number

 

Exercise

 

Exercise Prices

 

Outstanding

 

Life

 

Price

 

Exercisable

 

Price

 

 

 

 

 

(in thousands)

 

 

 

 

 

(in thousands)

 

 

 

$

 5.10

to

$

6.86

 

384

 

5.5

 

$

6.28

 

259

 

$

6.01

 

6.90

to

7.25

 

383

 

7.4

 

7.00

 

156

 

7.01

 

7.31

to

7.31

 

400

 

7.7

 

7.31

 

50

 

7.31

 

7.32

to

8.96

 

330

 

5.4

 

8.10

 

254

 

8.22

 

9.01

to

9.01

 

440

 

4.8

 

9.01

 

440

 

9.01

 

9.23

to

9.51

 

429

 

6.2

 

9.44

 

244

 

9.41

 

9.64

to

10.06

 

694

 

1.6

 

9.88

 

694

 

9.88

 

10.36

to

35.25

 

1,184

 

4.0

 

13.65

 

1,172

 

13.67

 

$

 5.10

to

$

35.25

 

4,244

 

4.8

 

$

9.83

 

3,269

 

$

10.48

 

 

Restricted Stock Units

 

The following table summarizes the Company’s restricted stock units as of and for the nine months ended September 30, 2009:

 

 

 

 

 

Weighted

 

 

 

 

 

Average

 

 

 

Restricted

 

Grant Date

 

 

 

Stock Units

 

Fair Value

 

 

 

(in thousands)

 

 

 

Nonvested as of December 31, 2008

 

4,123

 

$

7.20

 

Granted

 

352

 

7.39

 

Vested

 

(1,781

)

7.19

 

Forfeited

 

(285

)

7.20

 

Nonvested as of September 30, 2009

 

2,409

 

$

7.23

 

 

The fair value of restricted stock units is determined based on the closing price of the Company’s common stock on the grant date. The weighted-average grant date fair value of restricted stock units granted during the nine months ended September 30, 2008 and 2009 was $7.20 and $7.39, respectively. As of September 30, 2009, there was $6.9 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 1.6 years. The total fair value of shares vested during the nine months ended September 30, 2008 and 2009 was $5.7 million and $13.5 million, respectively, 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.

 

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EARTHLINK, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

UNAUDITED - (Continued)

 

11. Income Taxes

 

EarthLink recorded an income tax provision of $7.9 million and $16.9 million during the three months ended September 30, 2008 and 2009, respectively, and $23.9 million and $55.8 million during the nine months ended September 30, 2008 and 2009, respectively. The income tax provision was based on management’s current expectations in accordance with the interim reporting requirements.

 

The major components of the income tax provision for the three and nine months ended September 30, 2008 and 2009 are as follows:

 

 

 

Three Months Ended

 

Nine Months Ended

 

 

 

September 30,

 

September 30,

 

 

 

2008

 

2009

 

2008

 

2009

 

 

 

(in thousands)

 

 

 

 

 

 

 

 

 

 

 

Federal alternative minumum tax

 

$

1,030

 

$

329

 

$

3,392

 

$

2,525

 

State income tax

 

2,967

 

884

 

4,225

 

4,179

 

Other

 

(100

)

 

(500

)

 

Current provision

 

3,897

 

1,213

 

7,117

 

6,704

 

 

 

 

 

 

 

 

 

 

 

Deferred provision

 

4,027

 

15,701

 

16,806

 

49,050

 

 

 

 

 

 

 

 

 

 

 

Total

 

$

7,924

 

$

16,914

 

$

23,923

 

$

55,754

 

 

During the year ended December 31, 2008, the Company released $65.6 million of its valuation allowance related to its deferred tax assets. These deferred tax assets primarily related to net operating loss carryforwards which the Company determined it would more likely than not be able to utilize due to the generation of sufficient taxable income in 2009. For the three and nine months ended September 30, 2009, the non-cash deferred tax provision recorded was primarily a result of the utilization of these federal and state net operating loss tax assets.  The current federal and state tax liabilities are payable as a result of limitations on net operating loss utilization associated with the alternative minimum tax calculation and state laws.

 

EarthLink continues to maintain a partial valuation allowance against its unrealized deferred tax assets, which include net operating loss carryforwards.  EarthLink may recognize additional deferred tax assets in future periods when they are determined to be more likely than not realizable.  To the extent EarthLink reports income 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.  The Company’s ability to use its 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.

 

The Company has identified its federal tax return and its state tax returns in California, Florida, Georgia and Illinois as “major” tax jurisdictions, for purposes of calculating its uncertain tax positions.  Periods extending back to 1994 are still subject to examination for all “major” jurisdictions. The Company believes that its income tax filing positions and deductions will be sustained on audit and does not anticipate any adjustments that will result in a material adverse effect on the Company’s financial condition, results of operations or cash flows.  The Company’s policy for recording interest and penalties associated with audits is to record such items as a component of income taxes.  No adjustments were made for uncertain tax positions during the quarter.

 

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Table of Contents

 

EARTHLINK, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

UNAUDITED - (Continued)

 

12.  Fair Value Measurements

 

Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date (an exit price). A three-tier fair value hierarchy is used to prioritize the inputs used in measuring fair value.  These tiers include: Level 1, defined as observable inputs such as quoted prices in active markets; Level 2, defined as inputs other than quoted prices in active markets that are either directly or indirectly observable; and Level 3, defined as unobservable inputs in which little or no market data exists, therefore requiring an entity to develop its own assumptions.

 

As of September 30, 2009, the Company held certain assets that are required to be measured at fair value on a recurring basis.  These included the Company’s cash equivalents,