Quarterly Report

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 March 31, 2008

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, a non-accelerated filer or a smaller reporting company (as defined in Rule 12b-2 of the Exchange Act):

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
		(Do not check if a smaller reporting company)

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 April 30, 2008, 109,735,842 shares of common stock, $.01 par value per share, were outstanding.

EARTHLINK, INC.

Quarterly Report on Form 10-Q

For the Quarterly Period Ended March 31, 2008

TABLE OF CONTENTS

Part I

Item 1. Financial Statements	1

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations	21

Item 3. Quantitative and Qualitative Disclosures About Market Risk	37

Item 4. Controls and Procedures	38

Part II

Item 1. Legal Proceedings	38

Item 1A. Risk Factors	38

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds	38

Item 5. Other Information	39

Item 6. Exhibits	39

Signatures	40

PART I

Item 1. Financial Statements.

EARTHLINK, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(in thousands, except per share data)

	December 31,			March 31,
	2007			2008
				(unaudited)
ASSETS
Current assets:
Cash and cash equivalents	$	173,827		$	240,957
Investments in marketable securities	93,204			7,065
Accounts receivable, net of allowance of $6,422 and $6,473 as of December 31, 2007 and March 31, 2008, respectively	41,483			40,080
Investments in other companies	—			56,572
Prepaid expenses	7,747			7,463
Current assets of discontinued operations	6,744			4,657
Other current assets	13,732			13,875
Total current assets	336,737			370,669
Long-term investments in marketable securities	21,564			72,001
Property and equipment, net	57,300			51,484
Long-term investments in other companies	62,923			10,167
Purchased intangible assets, net	46,276			42,151
Goodwill	202,277			194,472
Other long-term assets	8,149			7,993
Total assets	$	735,226		$	748,937
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Trade accounts payable	$	28,808		$	20,816
Accrued payroll and related expenses	29,118			18,634
Other accounts payable and accrued liabilities	69,867			70,123
Current liabilities of discontinued operations	15,930			8,955
Deferred revenue	44,626			41,601
Total current liabilities	188,349			160,129

Long-term debt	258,750			258,750
Other long-term liabilities	26,654			16,632
Total liabilities	473,753			435,511

Stockholders’ equity:
Convertible preferred stock, $0.01 par value, 100,000 shares authorized, 0 shares issued and outstanding as of December 31, 2007 and March 31, 2008	—			—
Common stock, $0.01 par value, 300,000 shares authorized, 186,490 and 186,863 shares issued as of December 31, 2007 and March 31, 2008, respectively, and 110,547 and 109,635 shares outstanding as of December 31, 2007 and March 31, 2008, respectively	1,865			1,869
Additional paid-in capital	2,047,268			2,054,235
Accumulated deficit	(1,184,119		)	(1,129,755		)
Treasury stock, at cost, 75,943 and 77,228 shares as of December 31, 2007 and March 31, 2008, respectively	(602,564		)	(611,689		)
Unrealized losses on investments	(977		)	(1,234		)
Total stockholders’ equity	261,473			313,426
Total liabilities and stockholders’ equity	$	735,226		$	748,937

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

EARTHLINK, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

	Three Months Ended March 31,
	2007			2008
	(in thousands, except per share data)
	(unaudited)

Revenues	$	324,147		$	263,074

Operating costs and expenses:
Service and equipment costs	109,791			96,792
Sales incentives	4,604			759
Total cost of revenues	114,395			97,551

Sales and marketing	99,269			30,916
Operations and customer support	60,072			39,224
General and administrative	43,261			24,926
Amortization of intangible assets	3,496			4,013
Facility exit, restructuring and other costs	—			1,030
Total operating costs and expenses	320,493			197,660

Income from operations	3,654			65,414
Net losses of equity affiliate	(29,346		)	—
Interest income and other, net	3,503			1,616
Income (loss) from continuing operations before income taxes	(22,189		)	67,030
Income tax provision	(169		)	(9,274		)
Income (loss) from continuing operations	(22,358		)	57,756
Loss from discontinued operations	(7,604		)	(3,392		)
Net income (loss)	$	(29,962	)	$	54,364

Basic net income (loss) per share
Continuing operations	$	(0.18	)	$	0.53
Discontinued operations	(0.06		)	(0.03		)
Basic net income (loss) per share	$	(0.24	)	$	0.50
Basic weighted average common shares outstanding	123,058			109,493

Diluted net income (loss) per share
Continuing operations	$	(0.18	)	$	0.52
Discontinued operations	(0.06		)	(0.03		)
Diluted net income (loss) per share	$	(0.24	)	$	0.49
Diluted weighted average common shares outstanding	123,058			110,300

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

EARTHLINK, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

	Three Months Ended
	March 31,
	2007			2008
	(in thousands)
	(unaudited)
Cash flows from operating activities:
Net income (loss)	$	(29,962	)	$	54,364
Adjustments to reconcile net income (loss) to net cash (used in) provided by operating activities:
Depreciation and amortization	13,227			10,519
(Gain) loss on disposals and impairments of fixed assets	(4		)	2,370
Net losses of equity affiliate	29,346			—
Stock-based compensation	7,905			5,152
Deferred income taxes	—			7,219
Other adjustments	(24		)	—
(Increase) decrease in accounts receivable, net	(897		)	1,223
Increase in prepaid expenses and other assets	(3,601		)	(6,303		)
Decrease in accounts payable and accrued and other liabilities	(16,983		)	(29,852		)
Decrease in deferred revenue	(400		)	(2,959		)
Net cash (used in) provided by operating activities	(1,393		)	41,733

Cash flows from investing activities:
Purchases of property and equipment	(13,312		)	(278		)
Purchases of subscriber bases	(1,865		)	(117		)
Proceeds from sales of fixed assets	36			—
Investments in marketable securities:
Purchases	(103,535		)	(53,027		)
Sales and maturities	81,385			86,059
Investments in and net advances to/from equity affiliate	(13,724		)	87
Net cash (used in) provided by investing activities	(51,015		)	32,724

Cash flows from financing activities:
Principal payments under capital lease obligations	(12		)	(145		)
Proceeds from exercises of stock options and other	2,775			1,943
Repurchases of common stock	—			(9,125		)
Net cash provided by (used in) financing activities	2,763			(7,327		)

Net (decrease) increase in cash and cash equivalents	(49,645		)	67,130
Cash and cash equivalents, beginning of period	158,369			173,827
Cash and cash equivalents, end of period	$	108,724		$	240,957

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

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 include dial-up Internet access, high-speed Internet access, voice services and web hosting services. The Company also provides value-added services, such as search, advertising and ancillary services sold as add-on features to the Company’s Internet access services. In addition, through the Company’s wholly-owned subsidiary, New Edge Networks, the Company provides secure multi-site managed data networks and dedicated Internet access 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 services, among others. The Company’s Business Services segment provides Internet access and related value-added services to businesses and communications carriers. These services include managed data networks, dedicated Internet access and web hosting, among others. For further information concerning the Company’s business segments, see Note 14, “Segment Information.”

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 months ended March 31, 2007 and 2008 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, 2007 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.

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 months ended March 31, 2008 are not necessarily indicative of the results anticipated for the entire year ending December 31, 2008.

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

In accordance with Statement of Financial Accounting Standards (“SFAS”) No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets,” the Company has reflected its municipal wireless broadband results of operations as discontinued operations for all periods presented. As of December 31, 2007 and March 31, 2008, the assets of the business were held for sale and the business has operations that are clearly distinguishable operationally and for financial reporting purposes from the rest of EarthLink. See Note 5, “Discontinued Operations,” for further discussion.

Reclassifications

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

EARTHLINK, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

UNAUDITED - (Continued)

3. 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 (loss) 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, convertible debt and contingently issuable shares (collectively “Common Stock Equivalents”), were exercised or converted into common stock. The dilutive effect of outstanding stock options, warrants, restricted stock units and convertible debt 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 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.

The following table sets forth the computation for basic and diluted net income per share for the three months ended March 31, 2008:

	Three Months Ended
	March 31, 2008
	(in thousands,
	except per share data)

Numerator
Income from continuing operations	$	57,756
Loss from discontinued operations	(3,392		)
Net income	$	54,364

Denominator
Basic weighted average common shares outstanding	109,493
Dilutive effect of Common Stock Equivalents	807
Diluted weighted average common shares outstanding	110,300

Basic net income per share
Continuing operations	$	0.53
Discontinued operations	(0.03		)
Basic net income per share	$	0.50

Diluted net income per share
Continuing operations	$	0.52
Discontinued operations	(0.03		)
Diluted net income per share	$	0.49

During the three months ended March 31, 2008, approximately 10.1 million 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 period. Approximately 28.4 million shares that underlie the Company’s convertible debt instruments and 28.4 million warrants were also excluded from the calculation of diluted EPS because the exercise prices exceeded the Company’s average stock price during the period. These securities could be dilutive in future periods.

The Company has not included the effect of Common Stock Equivalents in the calculation of diluted EPS for the three months ended March 31, 2007 because such inclusion would have an anti-dilutive effect due to

EARTHLINK, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

UNAUDITED - (Continued)

the Company’s net loss. As of March 31, 2007, the Company had 19.6 million options outstanding, 1.0 million restricted stock units outstanding and 28.5 million warrants outstanding.

4. Facility Exit, Restructuring and Other Costs

Facility exit, restructuring and other costs consisted of the following during the three months ended March 31, 2007 and 2008 :

	Three Months Ended March 31,
	2007		2008
	(in thousands)

2007 Restructuring Plan	$	—	$	1,093
Legacy Restructuring Plans	—		(63		)
	$	—	$	1,030

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 is consolidating its office facilities in Atlanta, Georgia and Pasadena, California. The 2007 Plan was primarily implemented during the latter half of 2007 and is expected to be completed during 2008. In connection with the 2007 Plan, the Company expects to record total costs of approximately $73.0 to $83.0 million, including $30.0 to $32.0 million for severance and personnel-related costs, $15.0 to $20.0 million for lease termination and facilities-related costs, $26.0 to $28.0 million for non-cash asset impairments and $2.0 to $3.0 million for other associated costs.

As a result of the 2007 Plan, EarthLink recorded facility exit and restructuring costs of $1.1 million during the three months ended March 31, 2008, including $0.4 million for severance and personnel-related costs; $0.3 million for non-cash asset impairments; and $0.4 million for other associated costs. Such costs have been classified as facility exit, restructuring and other costs in the Condensed Consolidated Statement of Operations. The cumulative costs incurred to date as of March 31, 2008 include $30.6 million for severance and personnel-related costs; $12.2 million for lease termination and facilities-related costs; $21.0 million for non-cash asset impairments; and $1.5 million for other associated costs.

Management continues to evaluate EarthLink’s businesses and, therefore, there may be supplemental provisions for new plan initiatives as well as changes in estimates to amounts previously recorded, as payments are made or actions are completed.

The following table summarizes activity for the liability balances associated with the 2007 Plan for the three months ended March 31, 2008, including changes during the period 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, 2007	$	12,041		$	16,124		$	—		$	—		$	28,165
Accruals	367			—			286			440			1,093
Payments	(11,462		)	(1,179		)	—			(185		)	(12,826		)
Non-cash charges	—			—			(286		)	—			(286		)
Balance as of March 31, 2008	$	946		$	14,945		$	—		$	255		$	16,146

EARTHLINK, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

UNAUDITED - (Continued)

Facility exit and restructuring liabilities due within one year of the balance sheet date are classified as other accounts payable and accrued liabilities and facility exit and restructuring liabilities due after one year are classified as other long-term liabilities in the Condensed Consolidated Balance Sheets. Of the unpaid balance as of March 31, 2008, approximately $5.7 million associated with the 2007 Plan was classified as other accounts payable and accrued liabilities and $10.4 million was classified as other long-term liabilities.

Legacy Restructuring Plans

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, restructuring and other costs in the Condensed Consolidated Statements of Operations. During the three months ended March 31, 2008, EarthLink recorded a $0.1 million reduction to facility exit, restructuring and other costs as a result of changes in estimates for legacy restructuring plans.

5. Discontinued Operations

In November 2007, management concluded that the 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 on the Condensed Consolidated Balance Sheets and presented the municipal wireless broadband results of operations as discontinued operations for all periods presented. The municipal wireless broadband results of operations were previously included in the Consumer Services segment. The Company expects to complete the divestiture of its municipal wireless broadband assets during 2008.

Subsequent to March 31, 2008, the Company reached agreements with the cities of Corpus Christi, TX and Milpitas, CA to transfer ownership of its municipal wireless broadband networks to those respective cities in exchange for releasing the Company from its existing network agreements. Additionally, the Company plans to terminate its municipal wireless broadband service in New Orleans, LA and remove its network from the market.

In accordance with SFAS No. 144, the Company recorded a $1.9 million charge during the three months ended March 31, 2008 related to its municipal wireless broadband operations to adjust the carrying value of the long-lived assets to their fair value less estimated costs to sell. These charges are reflected within discontinued operations in the Condensed Consolidated Statement of Operations.

The following table presents summarized results of operations related to the Company’s discontinued operations for the three months ended March 31, 2007 and 2008:

	Three Months Ended March 31,
	2007			2008
	(in thousands)

Revenues	$	259		$	737
Loss from discontinued operations	(7,604		)	(3,392		)

The assets of discontinued operations as of December 31, 2007 and March 31, 2008 consisted primarily of property and equipment and the liabilities of discontinued operations as of December 31, 2007 and March 31, 2008 consisted primarily of accruals for purchases of property and equipment. Pursuant to SFAS No. 144, as of December 31, 2007 and March 31, 2008, the assets were reported at their estimated fair value less costs to sell and are no longer being depreciated.

EARTHLINK, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

UNAUDITED - (Continued)

6. 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.” The Company has invested in government agency notes, asset-backed debt securities (including auction rate 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. 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. Investments in marketable securities with maturities greater than one year from the balance sheet date are considered long-term investments in marketable securities. Long-term investments in marketable securities as of March 31, 2008 also include 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 investments were included in short-term investments in marketable securities as of December 31, 2007.

As of March 31, 2008, the Company’s long-term investments in marketable securities included auction rate securities with a par value of $57.8 million and a fair value of $55.1 million. During the three months ended March 31, 2008, auctions for these securities failed to attract sufficient buyers, resulting in the Company continuing to hold such securities. 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 United States Department of Education. The Company may not be able to access these funds until a successful auction occurs or until the underlying notes mature. Due to uncertainty surrounding the timing of a market recovery, the Company has classified its auction rate securities as long-term investments in marketable securities in the Condensed Consolidated Balance Sheet as of March 31, 2008. As a result of temporary declines in the fair value of the Company’s auction rate securities, which the Company attributes to liquidity issues rather than credit issues, it has recorded an unrealized loss of $2.7 million as of March 31, 2008. The Company will continue to evaluate the fair value of its investments in auction rate securities each reporting period for a potential other-than-temporary impairment.

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, 2007, gross unrealized gains were $0.1 million and gross unrealized losses were nominal. As of March 31, 2008, gross unrealized gains were $0.1 million and gross unrealized losses were $2.7 million. The Company believes its gross unrealized losses are temporary impairments as management has the intent and ability to hold these investments until maturity or until the market price fully recovers, at which time the Company would expect to receive the amortized cost basis of the investments 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 experienced any significant realized gains or losses on its investments in marketable securities during the periods presented.

EARTHLINK, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

UNAUDITED - (Continued)

Investments in other companies

Investments in other companies consisted of the following as of December 31, 2007 and March 31, 2008:

	As of		As of
	December 31,		March 31,
	2007		2008
	(in thousands)
Investments stated at fair value	$	52,923	$	56,739
Investments stated at cost	10,000		10,000
Total investments in other companies	$	62,923	$	66,739

Reported as:
Short-term investments in other companies	$	—	$	56,572
Long-term investments in other companies	62,923		10,167
Total investments in other companies	$	62,923	$	66,739

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 gains (losses) included in stockholders’ equity and accumulated other comprehensive income (loss). As of December 31, 2007, gross unrealized losses were $1.1 million and there were no gross unrealized gains. As of March 31, 2008, gross unrealized losses were $0.5 million and gross unrealized gains were $1.8 million.

T he Company’s investments in other companies as of March 31, 2008 included 6.1 million shares of Covad Communications Group, LLC (“Covad”) common stock and $50.6 million aggregate principal amount of 12% Senior Secured Convertible Notes due 2011 (the “Covad Notes”), which includes accrued and unpaid interest. In April 2008, Platinum Equity, LLC completed a transaction in which all outstanding shares of Covad were acquired. Upon closing of the transaction, a change of control of Covad occurred, resulting in Covad’s repurchase of all Covad Notes held by EarthLink at a purchase price equal to 100% of the principal amount thereof plus accrued and unpaid interest. As a result, in April 2008, the Company received cash of $50.8 million for the aggregate principal amount of the Covad Notes plus accrued interest. The Company expects to receive cash of $6.3 million for the 6.1 million shares of common stock in May 2008.

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. During the three months ended March 31, 2007 and 2008, the Company did not recognize any losses due to other-than-temporary declines of the value of its investments in other companies.

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. HELIO was formed in March 2005 and began offering its products and services in April 2006. As of March 31, 2008, EarthLink had an approximate 29% economic ownership interest and 30% voting interest in HELIO, while SK Telecom had an approximate 67% economic ownership interest and 70% voting interest in HELIO.

EARTHLINK, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

UNAUDITED - (Continued)

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. The Company had been recording its proportionate share of HELIO’s net loss in its Consolidated Statements of Operations and amortizing the difference between the book value and fair value of non-cash assets contributed to HELIO over their estimated useful lives. The amortization increased the carrying value of the Company’s investment and decreased the net losses of equity affiliate included in the Consolidated Statements of Operations. During the three months ended March 31, 2007, the Company recorded $29.3 million 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 2007, EarthLink discontinued recording additional net losses of equity affiliate because the carrying value of its investments in HELIO were reduced to zero, and EarthLink is not committed to provide further financial support to HELIO.

7. Purchased Intangible Assets and Goodwill

Goodwill

During the three months ended March 31, 2008, the carrying amount of goodwill decreased $7.8 million due to the utilization of net operating loss carryforwards acquired from OneMain.com, Inc., Cidco Incorporated, PeoplePC Inc., and New Edge Networks.

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, 2007 and March 31, 2008:

	As of December 31, 2007							As of March 31, 2008
	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	$	118,702	$	(79,763	)	$	38,939	$	118,590	$	(83,450	)	$	35,140
Software, technology and other	3,892		(3,161		)	731		3,892		(3,411		)	481
Trade names	—		—			—		1,521		(76		)	1,445
	122,594		(82,924		)	39,670		124,003		(86,937		)	37,066
Intangible assets not subject to amortization:
Trade names	6,606		—			6,606		5,085		—			5,085
	$	129,200	$	(82,924	)	$	46,276	$	129,088	$	(86,937	)	$	42,151

Amortization of intangible assets in the Condensed Consolidated Statements of Operations for the three months ended March 31, 2007 and 2008 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, certain 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 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 March 31, 2008, the weighted average amortization periods were 3.9 years for subscriber base assets and customer relationships, 4.1 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 $10.3 million during the remaining nine months in the year ending December 31, 2008 and $11.0 million, $7.4 million, $6.3 million and $2.0 million during the years ending December 31, 2009, 2010, 2011 and

EARTHLINK, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

UNAUDITED - (Continued)

2012, 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. 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, 2007 and March 31, 2008, the fair value of the Notes was approximately $262.0 million and $277.5 million, respectively, based on the 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 9, “Stockholders’ Equity,” for more information on the Call Spread Transactions.

EARTHLINK, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

UNAUDITED - (Continued)

9. 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 months ended March 31, 2007 and 2008 was as follows:

	Three Months Ended
	March 31,
	2007			2008
	(in thousands)
Net income (loss)	$	(29,962	)	$	54,364
Net change in unrealized losses on investments	(4,543		)	(257		)
Total comprehensive income (loss)	$	(34,505	)	$	54,107

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 March 31, 2008, the Company had $191.8 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.

The Company repurchased 1.3 million shares of its common stock for $9.1 million during the three months ended March 31, 2008. The Company did not repurchase any shares of its common stock during the three months ended March 31, 2007.

Call Spread Transactions

In connection with the issuance of the Notes (see Note 8, “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 at 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, 2007 and March 31, 2008, the estimated fair value of the call options was $43.8 million and $44.7 million, respectively.

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, 2007 and March 31, 2008, the estimated fair value of the warrants was $28.0 million and $29.4 million, respectively.

EARTHLINK, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

UNAUDITED - (Continued)

The Company has analyzed the Call Spread Transactions under Emerging Issues Task Force 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 addition to paid-in capital, and the Company will not recognize subsequent changes in fair value of the agreements.

10. 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 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. 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 $7.9 million and $5.2 million during the three months ended March 31, 2007 and 2008, respectively. In accordance with Staff Accounting Bulletin No. 107, the Company has classified stock-based compensation expense during the three months ended March 31, 2007 and 2008 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, phantom share 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 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 six 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, 2007 and March 31, 2008, approximately 43,000 phantom share units were outstanding.

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 three months ended March 31, 2008:

					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, 2007	13,427		$	10.69
Granted	114		7.06
Exercised	(320	)	6.00
Forfeited and expired	(1,734	)	11.30
Outstanding as of March 31, 2008	11,487		10.69		6.1	$	2,991
Vested and expected to vest as of March 31, 2008	10,856		$	10.85	5.9	$	2,785
Exercisable as of March 31, 2008	8,057		$	11.88	5.1	$	1,782

The aggregate intrinsic value amounts in the table above represent the closing price of the Company’s common stock on March 31, 2008 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 March 31, 2008. The total intrinsic value of options exercised during the three months ended March 31, 2007 and 2008 was $0.5 million and $0.5 million, respectively. The intrinsic value of stock options exercised represents the difference between the 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.

The following table summarizes the status of the Company’s stock options as of March 31, 2008:

									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	1,139	5.6	$	5.90	750	$	5.72
6.90		to	7.10		985	8.7	6.93		250	6.91
7.16		to	7.31		1,872	9.1	7.29		947	7.29
7.32		to	9.01		1,564	6.9	8.55		1,026	8.78
9.24		to	9.89		1,179	5.7	9.55		738	9.58
10.06		to	10.06		1,134	2.4	10.06		1,134	10.06
10.36		to	11.38		1,810	7.0	10.56		1,439	10.57
11.45		to	48.61		1,804	2.8	22.43		1,773	22.61
$	5.10	to	$	48.61	11,487	6.1	$	10.69	8,057	$	11.88

EARTHLINK, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

UNAUDITED - (Continued)

Valuation Assumptions for Stock Options

The fair value of stock options granted during the three months ended March 31, 2007 and 2008 was estimated using the Black-Scholes option-pricing model with the following assumptions:

	Three Months Ended March 31,
	2007		2008

Dividend yield	0	%	0	%
Expected volatility	43	%	39	%
Risk-free interest rate	4.80	%	3.00	%
Expected life	4.3 years		4.2 years

The weighted average grant date fair value of options granted during the three months ended March 31, 2007 and 2008 was $2.98 and $2.51, 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 curve 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.

Restricted Stock Units

The following table summarizes the Company’s restricted stock units as of and for the three months ended March 31, 2008:

			Weighted
			Average
	Restricted		Grant Date
	Stock Units		Fair Value

Nonvested as of December 31, 2007	2,061,000		$	7.17
Granted	3,290,000		7.16
Vested	(58,000	)	6.86
Forfeited	(218,000	)	7.12
Nonvested as of March 31, 2008	5,075,000		7.17

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 three months ended March 31, 2007 and 2008 was $7.32 and $7.16, respectively. As March 31, 2008, there was $28.2 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 2.6 years. The total fair value of shares vested during the three months ended March 31, 2007 and 2008 was $0.9 million and $0.4 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.

EARTHLINK, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

UNAUDITED - (Continued)

11. Income Taxes

EarthLink recorded an income tax provision of $9.3 million during the three months ended March 31, 2008 based on management’s current expectations for the results of operations for the year ending December 31, 2008 in accordance with the interim reporting requirements of SFAS No. 109, “Accounting for Income Taxes,” APB Opinion No. 28, “Interim Financial Reporting,” and FASB Interpretation No. 18 “Accounting for Income Taxes in Interim Periods — an interpretation of APB Opinion No. 28.” The major components of the provision for current income taxes during the three months ended March 31, 2008 were $1.2 million of federal alternative minimum tax (“AMT”) and $0.8 million of state income tax. A discrete item has been recorded during the three months ended March 31, 2008 for a change in valuation allowance resulting from a change in classification of an indefinite lived intangible asset to a definite lived intangible asset, corresponding to a decrease in the valuation allowance which resulted in a tax benefit of $0.5 million. A non-cash deferred tax provision of $7.8 million has been recorded for estimated utilization of federal and state net operating loss carryforwards acquired from OneMain.com, Inc., Cidco Incorporated, PeoplePC Inc., and New Edge Networks. The associated reduction in the valuation allowance due to the expected utilization of these acquired federal and state net operating losses has been recorded as a reduction to goodwill and not as a benefit to income taxes. The current AMT liability is payable as a result of net operating loss carryforward limitations associated with the AMT calculation.

EarthLink continues to maintain a full valuation allowance against its unrealized deferred tax assets, which include net operating loss carryforwards. EarthLink may recognize 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.

On January 1, 2007, EarthLink adopted Financial Interpretation (“FIN”) No. 48. The Company has identified its federal tax return and its state tax returns in California, Florida, Georgia and Illinois as “major” tax jurisdictions, as defined in FIN No. 48. Periods extending back to 1994 are still subject to examination for all “major” jurisdictions. The adoption of FIN No. 48 on January 1, 2007 did not result in a material cumulative-effect adjustment. 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 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.

12. Related Party Transactions

EarthLink and HELIO have entered into a services agreement pursuant to which EarthLink provides HELIO billing and other support services in exchange for management fees. 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 months ended March 31, 2007 and 2008, fees received for services provided to HELIO were $0.5 million and $0.4 million, respectively.

EarthLink purchases wireless Internet access devices and services from HELIO. During the three months ended March 31, 2007 and 2008, fees paid for products and services received from HELIO were $0.2 million and $0.1 million, respectively.

EARTHLINK, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

UNAUDITED - (Continued)

As of December 31, 2007 and March 31, 2008, the Company had accounts receivable from HELIO of approximately $0.2 million and $0.1 million, respectively.

13. Fair Value Measurements

On January 1, 2008, the Company adopted SFAS No. 157, “Fair Value Measurements,” which establishes a framework for reporting fair value and expands disclosures required for fair value measurements. Although the adoption of SFAS No. 157 did not materially impact its financial condition, results of operations or cash flow, the Company is now required to provide additional disclosures as part of its financial statements.

SFAS No. 157 defines fair value 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). SFAS No. 157 establishes a three-tier fair value hierarchy, which prioritizes 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 March 31, 2008, the Company held certain assets that are required to be measured at fair value on a recurring basis. These included the Company’s investments in marketable securities, including auction rate securities, and investments in other companies.

The following table presents the Company’s assets measured at fair value on a recurring basis subject to the disclosure requirements of SFAS No. 157 as of March 31, 2008:

			Fair Value Measurements as of March 31, 2008 Using
			Quoted Prices in		Significant Other		Significant
			Active Markets for		Observable		Unobservable
	Balance as of		Identical Assets		Inputs		Inputs
Description	March 31, 2008		(Level 1)		(Level 2)		(Level 3)
	(in thousands)
Auction rate securities	$	55,073	$	—	$	—	$	55,073
Other investments in marketable securities	23,993		23,993		—		—
Investments in other companies	56,739		6,179		50,560		—
Total	$	135,805	$	30,172	$	50,560	$	55,073

Investments in marketable securities, other than auction rate securities, and e quity investments in other companies are measured at fair value using quoted market prices and are classified within Level 1 of the valuation hierarchy. Debt investments in other companies are measured at fair value using quoted market prices for similar assets and are classified within Level 2 of the valuation hierarchy. The Company has consistently applied these valuation techniques in all periods presented.

The Company has invested in auction rate securities, which are more fully described in Note 6, “Investments.” Due to recent events in the credit markets, these instruments held by the Company failed to attract sufficient buyers during the three months ended March 31, 2008. Due to the lack of availability of observable market quotes, the fair values of the Company’s auction rate securities were estimated utilizing a discounted cash flow analysis as of March 31, 2008. These analyses consider, among other items, the collateralization underlying the security investments, the creditworthiness of the counterparty, and the timing and value of expected future cash flows. These securities were also compared, when possible, to other observable market data with similar characteristics to the securities held by the Company.

Based on market conditions, the Company changed its valuation methodology for auction rate securities to a discounted cash flow analysis during the three months ended March 31, 2008. Accordingly,

EARTHLINK, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

UNAUDITED - (Continued)

these securities changed from Level 1 to Level 3 within SFAS No. 157’s hierarchy since the Company’s initial adoption of SFAS No. 157 on January 1, 2008.

The following table presents the Company’s assets measured at fair value on a recurring basis using significant unobservable inputs (Level 3) as defined in SFAS No. 157 as of March 31, 2008:

	Auction
	Rate
	Securities
	(in thousands)
Balance as of December 31, 2007	$	—
Transfers to Level 3	38,900
Total unrealized losses	(2,677		)
Purchases and settlements (net)	18,850
Balance as of March 31, 2008	$	55,073

The $2.7 million of unrealized losses are included in unrealized gains (losses) on investments as a separate component of stockholders’ equity and in total comprehensive income (loss) and relate to assets held as of March 31, 2008.

14. 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. 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 Internet access services and related value-added services to individual customers. These services include dial-up and high-speed Internet access and voice services, among others. The Company’s Business Services segment provides Internet access 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, facility exit and restructuring costs, and stock-based compensation expense under SFAS No. 123(R), as they are not considered in the measurement of segment performance.

EARTHLINK, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

UNAUDITED - (Continued)

Information on reportable segments and a reconciliation to consolidated income from operations for the three months ended March 31, 2007 and 2008 is as follows:

	Three Months Ended March 31,
	2007		2008
	(in thousands)
Consumer Services
Revenues	$	276,393	$	216,344
Cost of revenues	84,353		71,173
Gross margin	192,040		145,171
Direct segment operating expenses	159,333		61,001
Segment operating income	$	32,707	$	84,170

Business Services
Revenues	$	47,754	$	46,730
Cost of revenues	30,042		26,378
Gross margin	17,712		20,352
Direct segment operating expenses	16,668		14,871
Segment operating income	$	1,044	$	5,481

Consolidated
Revenues	$	324,147	$	263,074
Cost of revenues	114,395		97,551
Gross margin	209,752		165,523
Direct segment operating expenses	176,001		75,872
Segment operating income	33,751		89,651
Stock-based compensation expense	7,880		5,152
Amortization of intangible assets	3,496		4,013
Facility exit, restructuring and other costs	—		1,030
Other operating expenses	18,721		14,042
Income from operations	$	3,654	$	65,414

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

EARTHLINK, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

UNAUDITED - (Continued)

Information on revenues by groups of similar services and by segment for the three months ended March 31, 2007 and 2008 is as follows:

	Three Months Ended March 31,
	2007		2008
	(in thousands)
Consumer Services
Access and service	$	242,800	$	188,971
Value-added services	33,593		27,373
Total revenues	$	276,393	$	216,344

Business Services
Access and service	$	46,955	$	45,878
Value-added services	799		852
Total revenues	$	47,754	$	46,730

Consolidated
Access and service	$	289,755	$	234,849
Value-added services	34,392		28,225
Total revenues	$	324,147	$	263,074

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, results of operations and identifiable assets are in the United States.

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, 2007.

Overview

EarthLink, Inc. is an Internet service provider, or ISP, providing nationwide Internet access and related value-added services to individual and business customers. Our primary service offerings include dial-up Internet access, high-speed Internet access, voice services and web hosting services. We also provide value-added services, such as search, advertising and ancillary services sold as add-on features to our Internet access services. In addition, through our wholly-owned subsidiary, New Edge Networks, we provide secure multi-site managed data networks and dedicated Internet access for businesses and communications carriers.

We operate two reportable segments, Consumer Services and Business Services. Our Consumer Services segment provides Internet access and related value-added services to individual customers. These services include dial-up and high-speed Internet access and voice services, among others. Our Business Services segment provides Internet access and related value-added services to businesses and communications carriers. These services include managed data networks, dedicated Internet access and web hosting, among others.

Industry Background

We operate in the Internet access market, which is characterized by intense competition, changing technology, evolving industry standards, changes in customer needs and new service and product introductions. The Internet access market has reached a mature stage of growth; however, growth is expected to continue at a slow rate as more services become available online, Internet access prices remain low, computer prices continue to decline and consumers increasingly gain access at places outside the home.

In the last few years, the composition of the Internet access market has changed and the number of households with broadband access surpassed the number of households with dial-up 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 downloads and photo sharing require greater bandwidth for optimal performance, which adds to the demand for broadband access. However, analysts predict a continuing market for dial-up customers.

Currently, most residential broadband consumers access the Internet via DSL or cable. 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 satellite; IP-based voice; and high-speed data networks for small and medium-sized businesses and communications carriers) and value-added services (including ancillary services sold as an add-on feature to our services, search and advertising). We earn revenues primarily from monthly fees charged to customers for services. We also earn revenues from usage fees; installation fees; termination fees; and fees for equipment used to access our services. Total revenues were $324.1 million and $263.1 million during the three months ended March 31, 2007 and 2008, respectively. Our traditional, premium-priced narrowband revenues have been declining due to the maturity of this service. In addition, our revenues declined over the past year due to a change in our business strategy to reduce sales and marketing activities which resulted in adding customers that did not provide an acceptable rate of return or that had a pattern of early life churn.

Business Strategy and Risks

In response to declining revenues, changes in our industry and changes in consumer behavior, we completed a comprehensive review of our core access services during the latter half of 2007. We also reviewed each of our prior growth initiatives to evaluate whether these initiatives were complementary to our long-term strategy and allowed us to maximize shareholder value. As a result of these reviews, we implemented a restructuring plan (“the 2007 Plan”) to reduce operating costs and improve the efficiency of our organization. Under the 2007 Plan, we significantly reduced employees, closed or consolidated certain facilities, discontinued certain projects and reduced sales and marketing efforts. For our core access services, we reduced the back-office cost structure and reduced sales and marketing efforts aimed at customers that had high acquisition costs and early life churn. For our IP-based voice and business services, we significantly reduced the cost structure. For our municipal wireless broadband operations, we concluded that the operations were no longer consistent with our strategic direction and we have committed to a plan to divest our municipal wireless broadband assets. Finally, we decided to discontinue further investments in HELIO, our joint venture with SK Telecom Co., Ltd. (“SK Telecom”), and entered into amended and restated joint venture agreements with SK Telecom to eliminate any future requirement to invest in HELIO.

Our current business focus is the following:

· Operational Efficiency . We are focused on improving the cost structure of our business and aligning our cost structure with trends in our revenue, without impacting the quality of services we provide. In addition to implementing our corporate restructuring plan which reduced back-office support costs and subscriber acquisition costs, we are focused on delivering our services more cost effectively by reducing and more efficiently handling the number of calls to contact centers, managing cost effective outsourcing opportunities and streamlining our internal processes and operations.

· Customer Retention . We are focused on retaining our existing tenured customers. We continue to focus on offering reasonably priced access with high-quality customer service and technical support. We believe focusing on the customer relationship will increase loyalty and reduce churn.

· Opportunities for growth . In response to changes in our business, we have significantly reduced our sales and marketing spending. However, we are focused on continuing to add customers that generate an acceptable rate of return and increasing the number of subscribers we add through partnerships and acquisitions from other ISPs. We will evaluate potential strategic transactions that could complement our business. We are also focused on adding customers organically by growing our services to business

customers through New Edge, our wholly-owned subsidiary. We believe this is a growth market and we will continue to differentiate ourselves by providing customers with choices for our business services.

The primary challenges we face in executing our business strategy are responding to competition, reducing churn, maintaining profitability in our access services and purchasing cost-effective wholesale broadband access. The factors we believe are instrumental to the achievement of our goals and targets, including the factors identified above, may be subject to competitive, regulatory and other events and circumstances that are beyond our control. Further, we can provide no assurance that we will be successful in achieving any or all of the factors identified above, that the achievement or existence of such factors will favorably impact profitability, or that other factors will not arise that would adversely affect future profitability.

First Quarter 2008 Highlights

Total revenues decreased during the three months ended March 31, 2008 compared to the prior year period. In addition, our subscriber base decreased from approximately 5.3 million paying subscribers as of March 31, 2007 to approximately 3.6 million paying subscribers as of March 31, 2008. The decrease in paying subscribers was primarily due to the removal of approximately 753,000 wholesale broadband subscribers under our marketing relationship with Embarq Corporation (“Embarq”), a decrease in premium narrowband subscribers and a decrease in PeoplePC value-priced narrowband subscribers. Overall operating expenses decreased during the three months ended March 31, 2008 compared to the prior year period primarily due to cost savings realized as a result of our 2007 corporate restructuring plan and a decrease in costs to acquire and support new subscribers. We recognized net income of $54.4 million during the three months ended March 31, 2008 compared to a net loss of $30.0 million during the three months ended March 31, 2007. This was due to the decrease in total operating costs and expenses and a decrease in net losses of HELIO, as we discontinued recording equity method losses during 2007. These improvements were partially offset by the decrease in revenues and an increase in our income tax provision.

Looking Ahead

We expect total revenues to continue to decrease as we reduce sales and marketing efforts aimed at customers that have a high acquisition cost and early life churn. However, we expect overall profits to increase in 2008 compared to the prior year as the benefits realized from our corporate restructuring plan, the decreased sales and marketing activities, the decreased support costs and the decrease in loss from equity affiliate more than offset our decline in revenues.

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. HELIO was formed in March 2005 and began offering its products and services in April 2006. As of March 31, 2008, we had an approximate 29% economic ownership interest and 30% voting interest in HELIO, while SK Telecom had an approximate 67% economic ownership interest and 70% voting interest in HELIO. We currently have no plans to make further investments in HELIO.

Marketing Alliance

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 March 31, 2008, more than 40% of our consumer broadband subscribers were serviced via either the Time Warner Cable or Bright House Networks network.

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:

	March 31,	December 31,	March 31,
	2007	2007	2008
Subscriber Data (a)
Consumer Services
Narrowband access subscribers	3,208,000	2,624,000	2,368,000
Broadband access subscribers (b)	1,847,000	1,059,000	1,026,000
Total consumer services	5,055,000	3,683,000	3,394,000
Business Services
Narrowband access subscribers	36,000	27,000	25,000
Broadband access subscribers	69,000	66,000	65,000
Web hosting accounts	109,000	100,000	97,000
Total business services	214,000	193,000	187,000
Total subscriber count at end of period	5,269,000	3,876,000	3,581,000

	Three Months Ended March 31,
	2007			2008
Subscriber Activity
Subscribers at beginning of period	5,313,000			3,876,000
Gross organic subscriber additions	668,000			253,000
Churn	(712,000		)	(548,000		)
Subscribers at end of period	5,269,000			3,581,000

Churn rate (c)	4.5		%	4.9		%

Consumer Services Data
Average subscribers (d)	5,085,000			3,538,000
ARPU (e)	$	18.13		$	20.38
Churn rate (c)	4.6		%	5.0		%

Business Services Data
Average subscribers (d)	217,000			190,000
ARPU (e)	$	73.32		$	81.88
Churn rate (c)	2.7		%	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) Customers who subscribe to our EarthLink DSL and Home Phone service are counted as both a broadband subscriber and a voice subscriber.

(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.

(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 .

(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 March 31,
	2007			2008			$ Change			% Change
	(dollars in thousands)

Revenues	$	324,147		$	263,074		(61,073		)	-19	%

Operating costs and expenses:
Service and equipment costs	109,791			96,792			(12,999		)	-12	%
Sales incentives	4,604			759			(3,845		)	-84	%
Total cost of revenues	114,395			97,551			(16,844		)	-15	%

Sales and marketing	99,269			30,916			(68,353		)	-69	%
Operations and customer support	60,072			39,224			(20,848		)	-35	%
General and administrative	43,261			24,926			(18,335		)	-42	%
Amortization of intangible assets	3,496			4,013			517			15	%
Facility exit, restructuring and other costs	—			1,030			1,030				*
Total operating costs and expenses	320,493			197,660			(122,833		)	-38	%

Income from operations	3,654			65,414			61,760				*
Net losses of equity affiliate	(29,346		)	—			29,346			-100	%
Interest income and other, net	3,503			1,616			(1,887		)	-54	%
Income (loss) from continuing operations before income taxes	(22,189		)	67,030			89,219				*
Income tax provision	(169		)	(9,274		)	(9,105		)		*
Income (loss) from continuing operations	(22,358		)	57,756			80,114				*
Loss from discontinued operations	(7,604		)	(3,392		)	4,212			-55	%
Net income (loss)	$	(29,962	)	$	54,364		$	84,326			*

* denotes percentage is not meaningful

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 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 the performance of our operating segments based on segment income from operations. Segment income from operations includes revenues from external customers, related cost of revenues and operating expenses directly attributable to the segment, which include expenses over which segment managers have direct discretionary control, such as advertising and marketing programs, customer support expenses, 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, facility exit and restructuring costs and stock-based compensation expense under Statement of Financial Accounting Standards (“SFAS”) No. 123(R), as they are not considered in the measurement of segment performance.

The following tables set forth segment data for the three months ended March 31, 2007 and 2008:

	Three Months Ended March 31,
	2007		2008		$ Change			% Change
	(dollars in thousands)
Consumer Services
Revenues	$	276,393	$	216,344	$	(60,049	)	-22	%
Cost of revenues	84,353		71,173		(13,180		)	-16	%
Gross margin	192,040		145,171		(46,869		)	-24	%
Direct segment operating expenses	159,333		61,001		(98,332		)	-62	%
Segment operating income	$	32,707	$	84,170	$	51,463		157	%

Business Services
Revenues	$	47,754	$	46,730	$	(1,024	)	-2	%
Cost of revenues	30,042		26,378		(3,664		)	-12	%
Gross margin	17,712		20,352		2,640			15	%
Direct segment operating expenses	16,668		14,871		(1,797		)	-11	%
Segment operating income	$	1,044	$	5,481	$	4,437		425	%

Consolidated
Revenues	$	324,147	$	263,074	$	(61,073	)	-19	%
Cost of revenues	114,395		97,551		(16,844		)	-15	%
Gross margin	209,752		165,523		(44,229		)	-21	%
Direct segment operating expenses	176,001		75,872		(100,129		)	-57	%
Segment operating income	33,751		89,651		55,900			166	%
Stock-based compensation expense	7,880		5,152		(2,728		)	-35	%
Amortization of intangible assets	3,496		4,013		517			15	%
Facility exit, restructuring and other costs	—		1,030		1,030				*
Other operating expenses	18,721		14,042		(4,679		)	-25	%
Income from operations	$	3,654	$	65,414	$	61,760			*

* denotes percentage is not meaningful

Revenues

The following table presents revenues by groups of similar services and by segment for the three months ended March 31, 2007