EarthLink (ELNK) 10-Q 2013 Q1 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, 2013

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 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. 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 April 30, 2013, 103,062,178 shares of common stock, $0.01 par value per share, were outstanding.

EARTHLINK, INC.

Quarterly Report on Form 10-Q

For the Quarterly Period Ended March 31, 2013

TABLE OF CONTENTS

Part I
Item 1.  Financial Statements	1
Item 2.  Management’s Discussion and Analysis of Financial Condition and Results of Operations	26
Item 3.  Quantitative and Qualitative Disclosures About Market Risk	45
Item 4.  Controls and Procedures	45
Part II
Item 1.  Legal Proceedings	46
Item 1A.  Risk Factors	46
Item 2.  Unregistered Sales of Equity Securities and Use of Proceeds	46
Item 5.  Other Information	46
Item 6.  Exhibits	47
Signatures	48

PART I

Item 1.  Financial Statements.

EARTHLINK, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(in thousands, except per share data)

	December 31, 2012			March 31, 2013
				(unaudited)
ASSETS
Current assets:
Cash and cash equivalents	$	157,621		$	146,148
Marketable securities	42,073			41,845
Restricted cash	1,013			1,013
Accounts receivable, net of allowance of $7,872 and $8,580 as of December 31, 2012 and March 31, 2013, respectively	112,765			109,953
Prepaid expenses	17,171			19,023
Deferred income taxes, net	15,954			9,902
Other current assets	20,303			24,042
Total current assets	366,900			351,926
Long-term marketable securities	4,778			4,108
Property and equipment, net	418,966			430,928
Long-term deferred income taxes, net	195,012			232,873
Goodwill	379,415			122,715
Other intangible assets, net	214,685			199,446
Other long-term assets	19,654			19,757
Total assets	$	1,599,410		$	1,361,753
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Accounts payable	$	18,792		$	17,271
Accrued payroll and related expenses	31,003			22,792
Other accrued liabilities	129,572			143,514
Deferred revenue	51,690			51,287
Current portion of long-term debt and capital lease obligations	1,375			1,399
Total current liabilities	232,432			236,263
Long-term debt and capital lease obligations	614,890			613,666
Other long-term liabilities	33,284			32,455
Total liabilities	880,606			882,384
Stockholders’ equity:
Convertible preferred stock, $0.01 par value, 100,000 shares authorized, 0 shares issued and outstanding as of December 31, 2012 and March 31, 2013	—			—
Common stock, $0.01 par value, 300,000 shares authorized, 196,919 and 197,242 shares issued as of December 31, 2012 and March 31, 2013, respectively, and 102,739 and 103,062 shares outstanding as of December 31, 2012 and March 31, 2013, respectively	1,969			1,972
Additional paid-in capital	2,057,974			2,054,950
Accumulated deficit	(606,148		)	(842,563		)
Treasury stock, at cost, 94,180 shares as of December 31, 2012 and March 31, 2013	(735,003		)	(735,003		)
Accumulated other comprehensive income	12			13
Total stockholders’ equity	718,804			479,369
Total liabilities and stockholders’ equity	$	1,599,410		$	1,361,753

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

1

EARTHLINK, INC.

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)

	Three Months Ended March 31,
	2012			2013
	(in thousands, except per share data) (unaudited)
Revenues	$	344,376		$	320,016
Operating costs and expenses:
Cost of revenues (exclusive of depreciation and amortization shown separately below)	159,337			154,424
Selling, general and administrative (exclusive of depreciation and amortization shown separately below)	110,069			108,069
Depreciation and amortization	45,254			43,400
Impairment of goodwill	—			256,700
Restructuring, acquisition and integration-related costs	3,521			11,401
Total operating costs and expenses	318,181			573,994
Income (loss) from operations	26,195			(253,978		)
Interest expense and other, net	(15,758		)	(14,556		)
Income (loss) before income taxes	10,437			(268,534		)
Income tax (provision) benefit	(3,174		)	32,119
Net income (loss)	$	7,263		$	(236,415	)
Net income (loss) per share
Basic	$	0.07		$	(2.30	)
Diluted	$	0.07		$	(2.30	)
Weighted average common shares outstanding
Basic	106,258			102,913
Diluted	106,926			102,913
Dividends declared per share	$	0.05		$	0.05
Comprehensive income (loss)	$	7,277		$	(236,414	)

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

2

EARTHLINK, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

	Three Months Ended March 31,
	2012			2013
Cash flows from operating activities:	(in thousands) (unaudited)
Net income (loss)	$	7,263		$	(236,415	)
Adjustments to reconcile net income (loss) to net cash provided by operating activities:
Depreciation and amortization	45,254			43,400
Impairment of goodwill	—			256,700
Loss (gain) on disposals and sales of fixed assets	502			(175		)
Non-cash income taxes	1,244			(32,248		)
Stock-based compensation	2,672			3,969
Amortization of debt discount, premium and issuance costs	(494		)	(414		)
Other operating activities	(219		)	(210		)
Decrease in accounts receivable, net	6,924			2,638
Decrease (increase) in prepaid expenses and other assets	3,965			(5,961		)
(Decrease) increase in accounts payable and accrued and other liabilities	(746		)	1,034
Decrease in deferred revenue	(154		)	(474		)
Net cash provided by operating activities	66,211			31,844
Cash flows from investing activities:
Purchases of property and equipment	(31,775		)	(42,454		)
Purchases of marketable securities	(19,187		)	(15,792		)
Sales and maturities of marketable securities	—			16,690
Purchase of customer relationships	—			(1,195		)
Change in restricted cash	718			—
Other investing activities	32			—
Net cash used in investing activities	(50,212		)	(42,751		)
Cash flows from financing activities:
Repayment of debt and capital lease obligations	(415		)	(381		)
Payment of dividends	(5,441		)	(199		)
Proceeds from exercises of stock options	46			—
Other financing activities	31			14
Net cash used in financing activities	(5,779		)	(566		)
Net increase (decrease) in cash and cash equivalents	10,220			(11,473		)
Cash and cash equivalents, beginning of period	211,783			157,621
Cash and cash equivalents, end of period	$	222,003		$	146,148

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

3

EARTHLINK, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

UNAUDITED

1.  Organization

EarthLink, Inc. (“EarthLink” or the “Company”), together with its consolidated subsidiaries, is a leading network, communications and IT services provider to business and residential customers in the United States. The Company operates two reportable segments, Business Services and Consumer Services. The Company’s Business Services segment provides a broad range of data, voice and IT services to retail and wholesale business customers. The Company’s Consumer Services segment provides nationwide Internet access and related value-added services to residential customers. The Company operates an extensive network including approximately 29,400 route fiber miles, 90 metro fiber rings and eight enterprise-class data centers that provide IP coverage across more than 90 percent of the United States. For further information concerning the Company’s reportable segments, see Note 14, “Segment Information.”

2. Summary of Significant Accounting Policies

Basis of Presentation

The condensed consolidated financial statements of EarthLink for the three months ended March 31, 2012 and 2013 and the related footnote information are unaudited and have been prepared on a basis consistent with the audited consolidated financial statements included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2012 as filed with the Securities and Exchange Commission (the “SEC”) (the “Annual Report”).

These financial statements should be read in conjunction with the audited consolidated financial statements and the related notes thereto contained in the 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, 2013 are not necessarily indicative of the results anticipated for the entire year ending December 31, 2013.

Basis of Consolidation

The accompanying condensed consolidated financial statements of EarthLink include the accounts of its wholly-owned subsidiaries. All significant intercompany transactions have been eliminated.

Use of Estimates

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.

Reclassifications

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

3.  Earnings per Share

The Company presents a dual presentation of basic and diluted earnings per share. Basic earnings per share represents net income (loss) divided by the weighted average number of common shares outstanding during the reported period. Diluted earnings per share reflects the potential dilution that could occur if securities or other contracts to issue common stock, including stock options and restricted stock units (collectively “Common Stock Equivalents”), were exercised, vested or converted into common stock. The dilutive effect, if any, of outstanding stock options and restricted stock units is reflected in diluted earnings per share by application of the treasury stock method. 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, the amount of compensation cost attributed to future services and not yet recognized and the amount of excess tax benefits, if any, that would be credited to additional paid-in capital assuming exercise of the awards.

4

EARTHLINK, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

UNAUDITED - (Continued)

The following table sets forth the computation for basic and diluted net income (loss) per share for the three months ended March 31, 2012 and 2013:

	Three Months Ended
	March 31,
	2012		2013
	(in thousands, except per share data)
Numerator
Net income (loss)	$	7,263	$	(236,415	)
Denominator
Basic weighted average common shares outstanding	106,258		102,913
Dilutive effect of Common Stock Equivalents	668		—
Diluted weighted average common shares outstanding	106,926		102,913
Basic net income (loss) per share	$	0.07	$	(2.30	)
Diluted net income (loss) per share	$	0.07	$	(2.30	)

During the three months ended March 31, 2012, approximately 2.4 million stock options and restricted stock units were excluded from the calculation of diluted earnings per share because their effect would have been anti-dilutive.  Anti-dilutive securities could be dilutive in future periods. The Company has not included the effect of Common Stock Equivalents in the calculation of diluted earnings per share for the three months ended March 31, 2013 because such inclusion would have an anti-dilutive effect due to the Company's net loss.

4.  Acquisitions

On April 1, 2011, EarthLink completed its acquisition of One Communications Corp. (“One Communications”), a privately-held integrated telecommunications solutions provider serving customers in the northeast, mid-Atlantic and upper midwest sections of the United States. The fair value of consideration transferred was $39.9 million which consisted of $20.0 million in cash and $19.9 million for the issuance of EarthLink common stock. The assets acquired and liabilities assumed of One Communications were recognized at their acquisition date fair values, which included $87.4 million of goodwill. Approximately 59% of the goodwill is deductible for income tax purposes.

Pursuant to the terms of the merger agreement, the aggregate merger consideration included $13.5 million (combination of cash and approximately 0.8 million shares of common stock) deposited into an escrow account to secure potential post-closing adjustments to the aggregate consideration relating to working capital and other similar adjustments. As of December 31, 2012, approximately $1.4 million of cash and 0.2 million shares of common stock valued at $1.4 million had been returned to EarthLink. During the three months ended March 31, 2013, an arbitrator made a final decision with respect to the post-closing working capital adjustments. Pursuant to the arbitrator's decision, the Company will receive an additional $1.9 million of cash and 0.2 million shares of common stock valued at $1.3 million from the escrow account.

5

EARTHLINK, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

UNAUDITED - (Continued)

5.  Restructuring, Acquisition and Integration-Related Costs

Restructuring, acquisition and integration-related costs consist of costs related to EarthLink’s restructuring, acquisition and integration-related activities. Such costs include: 1) severance and retention costs; 2) integration-related costs, such as system conversion, rebranding costs and integration-related consulting and employee costs; 3) transaction-related costs, which are direct costs incurred to effect a business combination, such as advisory, legal, accounting, valuation and other professional fees; and 4) facility-related costs, such as lease termination and asset impairments. Restructuring, acquisition and integration-related costs are expensed in the period in which the costs are incurred and the services are received and are included in restructuring, acquisition and integration-related costs in the Condensed Consolidated Statements of Comprehensive Income (Loss).  Restructuring, acquisition and integration-related costs consisted of the following during the three months ended March 31, 2012 and 2013:

	Three Months Ended
	March 31,
	2012			2013
	(in thousands)
Severance and retention costs	$	1,547		$	4,727
Integration-related costs	1,151			5,002
Transaction-related costs	839			104
Facility-related costs	165			1,568
Legacy plan restructuring costs	(181		)	—
Restructuring, acquisition and integration-related costs	$	3,521		$	11,401

During the three months ended March 31, 2013, the Company restructured its sales organization in order to better meet the needs of the IT services market, which resulted in a reduction in the Company's sales workforce and some office closings. As a result, the Company recorded $2.2 million of severance costs and $0.6 million of facility-related costs, which is included in restructuring, acquisition and integration-related costs in the Condensed Consolidated Statement of Comprehensive Loss.

6.  Investments in Marketable Securities

The Company’s marketable securities consisted of the following as of December 31, 2012 and March 31, 2013:

	As of December 31, 2012			As of March 31, 2013
	(in thousands)
Corporate debt securities	$	30,181		$	31,412
Government and agency securities	5,314			5,188
Commercial paper	9,293			8,291
Certificates of deposit	1,552			—
Municipal bonds	511			1,062
Total marketable securities	46,851			45,953
Less: classified as current	(42,073		)	(41,845		)
Total long-term marketable securities	$	4,778		$	4,108

Marketable securities consist of investments with original maturities greater than three months the date of acquisition. 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. As of March 31, 2013, all of the Company's long-term marketable securities were due within one to two years. These investments primarily consist of corporate debt securities, government and agency notes (which include U.S. treasury securities and government-sponsored debt securities), commercial paper, certificates of deposit and municipal bonds. These securities are classified as available for sale. Available-for-sale securities are carried at fair value, with any unrealized gains and losses, net of tax, included in accumulated other comprehensive income (loss) as a separate component of stockholders’ equity and in total comprehensive income (loss). Amounts reclassified out of accumulated other comprehensive income into earnings are determined

6

EARTHLINK, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

UNAUDITED - (Continued)

on a specific identification basis. Realized gains and losses on marketable securities are determined on a specific identification basis and included in interest expense and other, net, in the Condensed Consolidated Statements of Comprehensive Income (Loss).

The following tables summarize gross unrealized gains and losses as of December 31, 2012 and March 31, 2013 on the Company’s marketable securities designated as available-for-sale:

	As of December 31, 2012
	Amortized Cost		Gross Unrealized Losses		Gross Unrealized Gains		Estimated Fair Value
	(in thousands)
Corporate debt securities	$	30,173	$	—	$	8	$	30,181
Government and agency securities	5,311		—		3		5,314
Commercial paper	9,292		—		1		9,293
Certificates of deposit	1,552		—		—		1,552
Municipal bonds	511		—		—		511
	$	46,839	$	—	$	12	$	46,851

	As of March 31, 2013
	Amortized Cost		Gross Unrealized Losses			Gross Unrealized Gains		Estimated Fair Value
	(in thousands)
Corporate debt securities	$	31,401	$	(4	)	$	15	$	31,412
Government and agency securities	5,187		—			1		5,188
Commercial paper	8,291		—			—		8,291
Municipal bonds	1,061		—			1		1,062
	$	45,940	$	(4	)	$	17	$	45,953

7. Goodwill and Other Intangible Assets

Goodwill

The changes in the carrying amount of goodwill by operating segment during the three months ended March 31, 2013 were as follows:

	Consumer Services Segment		Business Services Segment			Total
	(in thousands)
Balance as of December 31, 2012
Goodwill	$	88,920	$	378,373		$	467,293
Accumulated impairment loss	—		(87,878		)	(87,878		)
	88,920		290,495			379,415
Goodwill impairment	—		(256,700		)	(256,700		)
Balance as of March 31, 2013
Goodwill	88,920		378,373			467,293
Accumulated impairment loss	—		(344,578		)	(344,578		)
	$	88,920	$	33,795		$	122,715

7

EARTHLINK, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

UNAUDITED - (Continued)

Other 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, 2012 and March 31, 2013:

	As of December 31, 2012							As of March 31, 2013
	Gross Carrying Value		Accumulated Amortization			Net Carrying Value		Gross Carrying Value		Accumulated Amortization			Net Carrying Value
	(in thousands)
Customer relationships	$	361,961	$	(160,513	)	$	201,448	$	363,156	$	(175,148	)	$	188,008
Developed technology and software	24,311		(14,801		)	9,510		24,311		(15,818		)	8,493
Trade names	9,121		(6,345		)	2,776		9,121		(6,978		)	2,143
Other	1,800		(849		)	951		1,800		(998		)	802
	$	397,193	$	(182,508	)	$	214,685	$	398,388	$	(198,942	)	$	199,446

Definite-lived intangible assets are amortized over their estimated useful lives. The Company’s customer relationships are being amortized using the straight-line method to match the estimated cash flow generated by such assets, and the developed technology and trade names are being amortized using the straight-line method because a pattern to which the expected benefits will be consumed or otherwise used up could not be reliably determined. As of March 31, 2013, the weighted average amortization periods were 5.3 years for customer relationships, 3.9 years for developed technology and software, 3.3 years for trade names and 4.4 years for other identifiable intangible assets.

Amortization of intangible assets, which is included in depreciation and amortization in the Condensed Consolidated Statements of Comprehensive Income (Loss), for the three months ended March 31, 2012 and 2013 was as follows:

	Three Months Ended
	March 31,
	2012		2013
	(in thousands)
Amortization expense	$	17,680	$	16,434

Based on the current amount of definite-lived intangible assets, the Company expects to record amortization expense of approximately $49.2 million during the remaining nine months in the year ending December 31, 2013 and $61.3 million, $59.3 million, $28.5 million, and $1.1 million during the years ending December 31, 2014, 2015, 2016, and 2017, respectively. Actual amortization expense to be reported in future periods could differ materially from these estimates as a result of acquisitions, changes in useful lives and other relevant factors.

Impairment of Goodwill

During the three months ended March 31, 2013, the Company recognized a $256.7 million non-cash impairment charge to goodwill related to its Business Services reporting unit. The impairment was based on an analysis of a number of factors after a decline in the Company's market capitalization following the announcement of its fourth quarter 2012 earnings and 2013 financial guidance. The primary factor contributing to the impairment was a change in the discount rate and market multiples as a result of the change in these market conditions, both key assumptions used in the determination of fair value.

The Company tests its goodwill annually during the fourth quarter of each fiscal year or when events or changes in circumstances indicate that goodwill might be impaired. The Company's stock price and market capitalization declined during the three months ended March 31, 2013 following the announcement in mid-February 2013 of the Company's fourth quarter 2012 earnings and 2013 financial guidance. As a result of the sustained decrease in stock price and market capitalization, the Company performed an interim goodwill test in conjunction with the preparation of its financial statements for the three months ended March 31, 2013.

8

EARTHLINK, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

UNAUDITED - (Continued)

Impairment testing of goodwill is required at the reporting unit level and involves a two-step process. The Company identified two reporting units for evaluating goodwill, which were Business Services and Consumer Services. Each of these reporting units constitutes a business for which discrete financial information is available and segment management regularly reviews the operating results. The first step of the impairment test involves comparing the estimated fair values of the Company's reporting units with the reporting units' carrying amounts, including goodwill. The Company estimated the fair values of its reporting units based on weighting of the income and market approaches. These models use significant unobservable inputs, or Level 3 inputs, as defined by the fair value hierarchy. Under the income approach, the fair value of the reporting unit was estimated based on the present value of estimated cash flows using a discounted cash flow method. The significant assumptions used in the discounted cash flow method included internal forecasts and projections developed by management for planning purposes, available industry/market data, strategic plans, discount rates and the growth rate to calculate the terminal value. Under the market approach, the fair value was estimated using the guideline company method. The Company selected guideline companies in the industry where each reporting unit operates.

Upon completion of the first step, the Company determined that the carrying value of its Business Services reporting unit exceeded its estimated fair value, so a second step was performed to compare the carrying amount of goodwill to the implied fair value of that goodwill. The implied fair value of goodwill for the Business Services reporting unit was determined in the same manner as utilized to recognize goodwill in a business combination. To determine the implied value of goodwill, estimated fair values were allocated to the identifiable assets and liabilities of the Business Services reporting unit as of March 31, 2013. The implied fair value of goodwill was measured as the excess of the fair value of the Business Services reporting unit over the amounts assigned to its identifiable assets and liabilities. The impairment loss of $256.7 million during the three months ended March 31, 2013 was measured as the amount the carrying value of goodwill exceeded the implied fair value of the goodwill. Of this amount, $49.3 million was deductible for tax purposes. Approximately $33.8 million of goodwill attributable to the Business Services reporting unit remains as of March 31, 2013. The Company is still finalizing the second step of its goodwill impairment test. As such, the measurement of the impairment loss is an estimate and may require adjustment in a subsequent reporting period.

8.  Other Accrued Liabilities

Other accrued liabilities consisted of the following as of December 31, 2012 and March 31, 2013:

	As of December 31, 2012		As of March 31, 2013
	(in thousands)
Accrued taxes and surcharges	$	33,016	$	32,352
Accrued communications costs	39,174		32,486
Accrued interest	11,066		25,589
Amounts due to customers	15,913		17,451
Facility exit and restructuring liabilities	3,211		3,865
Other	27,192		31,771
Total other accrued liabilities	$	129,572	$	143,514

9

EARTHLINK, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

UNAUDITED - (Continued)

9.  Long-Term Debt and Capital Lease Obligations

The Company’s long-term debt and capital lease obligations consisted of the following as of December 31, 2012 and March 31, 2013:

	As of December 31, 2012			As of March 31, 2013
	(in thousands)
ITC^DeltaCom senior secured notes due April 2016	$	292,300		$	292,300
Unamortized premium on ITC^DeltaCom senior secured notes due April 2016	15,694			14,605
EarthLink senior notes due May 2019	300,000			300,000
Unamortized discount on EarthLink senior notes due May 2019	(8,818		)	(8,563		)
Capital lease obligations	17,089			16,723
Carrying value of debt and capital lease obligations	616,265			615,065
Less current portion of debt and capital lease obligations	(1,375		)	(1,399		)
Long-term debt and capital lease obligations	$	614,890		$	613,666

ITC^DeltaCom Senior Secured Notes due April 2016

General.  In connection with the EarthLink’s acquisition of ITC^DeltaCom, Inc. (“ITC^DeltaCom”) in December 2010, EarthLink assumed ITC^DeltaCom’s outstanding $325.0 million aggregate principal amount of 10.5% senior secured notes due on April 1, 2016 (the “ITC^DeltaCom Notes”). The ITC^DeltaCom Notes were not repaid or guaranteed by EarthLink.  The ITC^DeltaCom Notes were recorded at acquisition date fair value, which was based on publicly-quoted market prices. The resulting debt premium of $26.3 million is being amortized over the remaining life of the ITC^DeltaCom Notes using the effective interest method.

Under the indenture for the ITC^DeltaCom Notes, following the consummation of the acquisition, ITC^DeltaCom was required to offer to repurchase any or all of the ITC^DeltaCom Notes at 101% of their principal amount.  The tender window was open from December 20, 2010 through January 18, 2011. As a result, approximately $0.2 million outstanding principal amount of the ITC^DeltaCom Notes was repurchased in January 2011. The remaining ITC^DeltaCom Notes remain outstanding as obligations of ITC^DeltaCom and its subsidiaries.

The ITC^DeltaCom Notes accrue interest at a rate of 10.5% per year. Interest on the ITC^DeltaCom Notes is payable semi-annually in cash in arrears on April 1 and October 1 of each year. The ITC^DeltaCom Notes will mature on April 1, 2016.

Redemption.  ITC^DeltaCom may redeem some or all of the ITC^DeltaCom Notes, at any time before April 1, 2013, at a redemption price equal to 100% of their principal amount plus a “make-whole” premium. ITC^DeltaCom may redeem some or all of the ITC^DeltaCom Notes at any time on or after April 1, 2013, at specified redemption prices declining from 105.250% to 100% of their principal amount. In addition, before April 1, 2013, ITC^DeltaCom may redeem up to 35% of the aggregate principal amount of the ITC^DeltaCom Notes at a redemption price equal to 110.5% of their principal amount with the net proceeds of certain equity offerings. During any 12-month period before April 1, 2013, ITC^DeltaCom may redeem up to 10% of the aggregate principal amount of the ITC^DeltaCom Notes at a redemption price equal to 103% of their principal amount.

In December 2012, the Company exercised its right to call for the redemption of 10% of the aggregate principal amount of its outstanding ITC^DeltaCom Notes. The Company redeemed $32.5 million aggregate principal amount of the ITC^DeltaCom Notes on December 6, 2012. The redemption price was equal to 103% of the principal amount thereof, plus accrued and unpaid interest. Upon completion of the redemption, $292.3 million aggregate principal amount of the ITC^DeltaCom Notes remained outstanding. The Company recognized an $0.8 million gain on redemption.

If (1) ITC^DeltaCom sells certain of its assets and does not either (a) apply the net sale proceeds to repay indebtedness under the ITC^DeltaCom Notes or other indebtedness secured on a first-priority basis or (b) reinvest the net sale proceeds in its business or (2) ITC^DeltaCom experiences a change of control, ITC^DeltaCom may be required to offer to purchase ITC^DeltaCom Notes from holders at 100% of their principal amount, in the case of a sale of assets, or 101% of their principal amount, in the case of a change of control. ITC^DeltaCom would be required to pay accrued and unpaid interest, if any, on the ITC^DeltaCom Notes redeemed or purchased in each of the foregoing events of redemption or purchase.

10

EARTHLINK, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

UNAUDITED - (Continued)

Ranking and guaranty. The ITC^DeltaCom Notes are ITC^DeltaCom’s general senior obligations and rank equally in right of payment with any future senior indebtedness. The ITC^DeltaCom Notes are secured on a first-priority basis, along with any future pari passu secured obligations, subject to specified exceptions and permitted liens, by substantially all of the assets of ITC^DeltaCom and its subsidiaries that are deemed to be restricted subsidiaries under the indenture governing the ITC^DeltaCom Notes. Currently all of ITC^DeltaCom’s subsidiaries are deemed to be restricted subsidiaries under the indenture.

The ITC^DeltaCom Notes are guaranteed on a senior secured basis by each of ITC^DeltaCom’s restricted subsidiaries on the initial issue date of the ITC^DeltaCom Notes and will be guaranteed on a senior secured basis by each future domestic restricted subsidiary, other than certain excluded subsidiaries, and by any foreign restricted subsidiary that guarantees any indebtedness of ITC^DeltaCom or any domestic restricted subsidiary. The guarantees are the subsidiary guarantors’ general senior obligations and rank equally in right of payment with all of the subsidiary guarantors’ existing and future senior indebtedness.

Covenants. The indenture governing the ITC^DeltaCom Notes contains covenants that, among other things, limit ITC^DeltaCom’s ability, and the ability of ITC^DeltaCom’s restricted subsidiaries, to incur additional indebtedness, create liens, pay dividends on, redeem or repurchase ITC^DeltaCom’s capital stock, make investments or repay subordinated indebtedness, engage in sale-leaseback transactions, enter into transactions with affiliates, sell assets, create restrictions on dividends and other payments to ITC^DeltaCom from its subsidiaries, issue or sell stock of subsidiaries and engage in mergers and consolidations. All of the covenants are subject to a number of important qualifications and exceptions under the indenture. As of March 31, 2013, ITC^DeltaCom was in compliance with all of its covenants.

EarthLink Senior Notes due May 2019

General.  In May 2011, the Company completed a private placement of $300.0 million aggregate principal amount of 8-7/8% Senior Notes due 2019 (the “Senior Notes”).  The Senior Notes were issued at 96.555% of their principal amount, resulting in gross proceeds of approximately $289.7 million and net proceeds of $280.2 million after deducting transaction fees of $9.5 million. In September 2011, in accordance with the registration rights granted to the original purchasers of the Senior Notes, the Company completed an exchange offer of the privately placed Senior Notes for new 8-7/8% Senior Notes due 2019 registered with the SEC with substantially identical terms to the original Senior Notes.

The Senior Notes accrue interest at a rate of 8-7/8% per year, payable on May 15 and November 15 of each year, commencing on November 15, 2011. The Senior Notes will mature on May 15, 2019.

Redemption.  The Company may redeem the Senior Notes, in whole or in part, (i) from May 15, 2015 until May 15, 2016 at a price equal to 104.438% of the principal amount of the Senior Notes redeemed; (ii) from May 15, 2016 until May 15, 2017 at a price equal to 102.219% of the principal amount of the Senior Notes redeemed; and (iii) from May 15, 2017 at a price equal to 100% of the principal amount of the Senior Notes redeemed, in each case plus accrued and unpaid interest.  Prior to May 15, 2015, the Company may also redeem the Senior Notes, in whole or in part, at a price equal to 100% of the aggregate principal amount of the Senior Notes to be redeemed plus a make-whole premium and accrued and unpaid interest.  In addition, prior to May 15, 2014, the Company may redeem up to 35% of the aggregate principal amount of the Senior Notes with the net cash proceeds of certain equity offerings at a price equal to 108.875% of the principal amount of the Senior Notes redeemed, plus accrued and unpaid interest.

Ranking and guaranty. The Senior Notes and the related guarantees of certain of the Company’s wholly-owned subsidiaries (the “Guarantors”) are the Company’s and the Guarantors’ unsecured senior obligations and rank equally with all of the Company’s and the Guarantors’ other senior indebtedness.

Covenants. The indenture governing the Senior Notes includes covenants which, subject to certain exceptions, limit the ability of the Company and its Restricted Subsidiaries (as defined in the indenture) to, among other things, incur additional indebtedness, make certain types of restricted payments, incur liens on assets of the Company or the Restricted Subsidiaries, engage in asset sales and enter into transactions with affiliates. Upon a change of control (as defined in the indenture), the Company may be required to make an offer to repurchase the Notes at 101% of their principal amount, plus accrued and unpaid interest. The indenture governing the Senior Notes also contains customary events of default. As of March 31, 2013, the Company was in compliance with these covenants.

11

EARTHLINK, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

UNAUDITED - (Continued)

Revolving Credit Facility

General.  On May 20, 2011, the Company entered into a credit agreement (the “Credit Agreement”) providing for a senior secured revolving credit facility with aggregate revolving commitments of $150.0 million. The senior secured revolving credit facility terminates on May 20, 2015, and all amounts outstanding thereunder shall be due and payable in full.  The Company paid $1.9 million of transaction fees related to the new senior secured revolving credit facility, which are being amortized to interest expense over the life of the credit facility using the straight-line method. Commitment fees and borrowing costs under this facility vary and are based the Company’s most recent Consolidated Leverage Ratio (as defined in the Credit Agreement).  As of March 31, 2013, the Company’s Commitment Fee was 0.375% and the Company’s borrowing cost would be LIBOR plus 2.50% for LIBOR Rate Loans and the Base Rate plus 1.50% for Base Rate Loans. No loans were outstanding under the senior secured revolving credit facility as of March 31, 2013. However, $1.6 million of letters of credit were outstanding under the facility’s Letter of Credit Sublimit as of March 31, 2013.

Prepayment. The Company may prepay the senior secured revolving credit facility in whole or in part at any time without premium or penalty, subject to reimbursement of the lenders’ breakage and redeployment costs in the case of prepayment of LIBOR borrowings. The Company may irrevocably reduce or terminate the unutilized portion of the senior secured revolving credit facility at any time without penalty.

Covenants. The Credit Agreement contains representations and warranties, covenants, and events of default with respect to the Company and its subsidiaries that are customarily applicable to senior secured credit facilities.  However, such covenants will not apply to ITC^DeltaCom and its subsidiaries until the earlier of (i) the repayment or refinancing in full of the ITC^DeltaCom Notes or (ii) the date ITC^DeltaCom and its U.S. subsidiaries become guarantors of the senior secured revolving credit facility.  ITC^DeltaCom is not currently a guarantor under the senior secured revolving credit facility. The negative covenants contained in the Credit Agreement include restrictions on the ability of the Company and its subsidiaries to, among other things, incur additional indebtedness, incur liens on assets, engage in certain mergers, acquisitions or divestitures, pay dividends or make other distributions, voluntarily prepay certain other indebtedness (including certain prepayments of the Company’s existing notes and the ITC^DeltaCom Notes), enter into transactions with affiliates, make investments, and change the nature of their businesses, and amend the terms of certain other indebtedness (including the Company’s existing notes and the ITC^DeltaCom Notes), in each case subject to certain exceptions set forth in the Credit Agreement.

Additionally, the Credit Agreement requires the Company to maintain a maximum consolidated leverage ratio and a minimum consolidated interest coverage ratio (as defined in the Credit Agreement). As of March 31, 2013, the Company was in compliance with these covenants. As a result of an increase in capital expenditures, the Company may not satisfy the minimum consolidated interest coverage ratio within the next twelve months. Based on discussion with the administrative agent for the Credit Agreement, the Company believes it would be able to amend the Credit Agreement to permit compliance with this covenant. However, if the Company breached this covenant, it would not be able to access funds under the revolving credit facility. This would not impact the Company's results of operations as no amounts are drawn under the credit facility. However, it would provide the Company with less flexibility for strategic transactions and other potential business needs.

Capital Lease Obligations

The Company maintains capital leases relating to indefeasible right-to-use agreements, vehicles and equipment. Depreciation expense related to assets under capital leases is included in depreciation and amortization expense in the Condensed Consolidated Statements of Comprehensive Income (Loss).

10.  Stockholders’ Equity

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, 2013, the Company had $73.5 million available under the current authorizations. The Company may repurchase its common stock from time to time in compliance with the Securities and Exchange Commission’s 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.

12

EARTHLINK, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

UNAUDITED - (Continued)

The Company did not repurchase any of its common stock pursuant to its share repurchase program during the three months ended March 31, 2012 and 2013.

Dividends

During the three months ended March 31, 2012 and 2013, cash dividends declared were $0.05 and $0.05 per common share, respectively. The Company also pays cash dividend amounts on each outstanding restricted stock unit to be paid at the time the restricted stock unit vests. Cash dividend amounts are forfeited if the restricted stock units do not vest. Total dividend payments were $5.4 million and $0.2 million during the three months ended March 31, 2012 and 2013, respectively. The Company currently intends to pay regular quarterly dividends on its common stock.  Any decision to declare future dividends will be made at the discretion of the Board of Directors and will depend on, among other things, the Company’s results of operations, financial condition, cash requirements, investment opportunities and other factors the Board of Directors may deem relevant. In addition, the agreements governing the Company’s Senior Notes and senior secured revolving credit facility contain restrictions on the amount of dividends the Company can pay.

11.  Stock-Based Compensation

The Company measures compensation cost for all stock awards at fair value on the date of grant and recognizes 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 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 $2.7 million and $4.0 million during the three months ended March 31, 2012 and 2013, respectively.  The Company has classified stock-based compensation expense within selling, general and administrative expense, the same operating expense line item as cash compensation paid to employees.

Stock Incentive Plans

The Company has granted options and restricted stock units to employees and non-employee directors to purchase the Company’s common stock 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 closing 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 years from the date of grant. Restricted stock units are granted with various vesting terms that range from one to three years from the date of grant.

13

EARTHLINK, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

UNAUDITED - (Continued)

Options Outstanding

The following table summarizes stock option activity as of and for the three months ended March 31, 2013:

	Stock Options		Weighted Average Exercise Price		Weighted Average Remaining Contractual Term (Years)	Aggregate Intrinsic Value
	(shares and dollars in thousands)
Outstanding as of December 31, 2012	3,723		$	8.12
Granted	2,301		6.08
Forfeited and expired	(165	)	7.49
Outstanding as of March 31, 2013	5,859		7.34		7.8	$	—
Vested and expected to vest as of March 31, 2013	5,667		$	7.36	7.7	$	—
Exercisable as of March 31, 2013	2,033		$	8.58	4.5	$	—

The aggregate intrinsic value amounts in the table above represent the closing price of the Company’s common stock on March 31, 2013 in excess of the exercise price, multiplied by the number of stock options outstanding, exercisable or vested and expected to vest, 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, 2013. The total intrinsic value of options exercised during the three months ended March 31, 2012 and 2013 was $13,000 and $0, respectively. The intrinsic value of stock options exercised represents the difference between the market value of Company’s common stock at the time of exercise and the exercise price, multiplied by the number of stock options exercised.  As of March 31, 2013, there was $5.6 million of total unrecognized compensation cost related to stock options. That cost is expected to be recognized over a weighted-average period of 3.3 years.

The following table summarizes the status of the Company’s stock options as of March 31, 2013:

									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)
$	6.08	to	$	6.08	2,302	9.9	$	6.08	—	$	—
6.31		to	6.98		104	4.1	6.89		104	6.89
7.02		to	7.32		324	4.2	7.27		324	7.27
7.51		to	7.51		1,975	8.9	7.51		553	7.51
7.64		to	8.96		196	6.2	8.34		94	8.21
9.01		to	9.24		247	1.6	9.03		247	9.03
9.48		to	9.89		292	2.6	9.51		292	9.51
10.36		to	11.82		419	2.3	10.60		419	10.60
$	6.08	to	$	11.82	5,859	7.8	$	7.34	2,033	$	8.58

14

EARTHLINK, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

UNAUDITED - (Continued)

The fair value of stock options granted during the three months ended March 31, 2013 was estimated using the Black-Scholes option-pricing model with the following assumptions:

	Three Months Ended
	March 31, 2013
Dividend yield	3.29%
Expected volatility	31.20%
Risk-free interest rate	0.88%
Expected life	5 years

The weighted average grant date fair value of options granted during the three months ended March 31, 2013 was $1.19 per share. The dividend yield assumption was based on the Company's history of dividend payouts at the time of grant. The expected volatility was based on a combination of the Company's historical stock price and implied volatility. The selection of implied volatility data to estimate expected volatility was based upon the availability of prices for actively traded options on the Company's stock. The risk-free interest rate assumption was 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 restricted stock unit activity as of and for the three months ended March 31, 2013:

	Restricted Stock Units		Weighted Average Grant Date Fair Value
	(in thousands)
Outstanding as of December 31, 2012	2,981		$	7.90
Granted	2,148		6.08
Vested	(547	)	8.23
Forfeited	(285	)	7.54
Outstanding as of March 31, 2013	4,297		$	6.97

The fair value of restricted stock units is determined based on the closing 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, 2012 and 2013 was $7.51 and $6.08, respectively.  As of March 31, 2013, there was $25.3 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 2.2 years. The total fair value of shares vested during the three months ended March 31, 2012 and 2013 was $3.8 million, which represents the closing price of the Company’s common stock on the vesting date multiplied by the number of restricted stock units that vested.

12.  Income Taxes

The following table presents the components of the income tax (provision) benefit for the three months ended March 31, 2012 and 2013:

	Three Months Ended
	March 31,
	2012			2013
	(in thousands)
Current provision	$	(1,930	)	$	(129	)
Deferred (provision) benefit	(1,244		)	32,248
Total income tax (provision) benefit	$	(3,174	)	$	32,119

15

EARTHLINK, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

UNAUDITED - (Continued)

The income tax provision for the three months ended March 31, 2013 represents an effective rate of 12%, including tax expense of $0.2 million for discrete items, which represents (.06)% of the effective tax rate.  The effective rate differs from the federal statutory rate of 35% primarily because of the impairment of non-deductible goodwill, as well as state taxes. The discrete expense for the three months ended March 31, 2013 relates to stock based compensation, prior year state tax items and additional penalties and interest related to uncertain tax positions. The current tax provision for the three months ended March 31, 2013 was due to the prior year state tax items and penalties and interest related to uncertain tax positions. The non-cash deferred tax benefit was due primarily to net operating loss carryforwards and the impairment of tax deductible goodwill.

Valuation allowance. The Company has a valuation allowance of $38.6 million against certain deferred tax assets. Of this amount, approximately $31.6 million relates to net operating losses generated by the tax benefits of stock-based compensation. The valuation allowance will be removed upon utilization of these net operating losses by the Company as an adjustment to additional paid-in-capital.  Approximately $6.6 million relates to net operating losses in certain jurisdictions where the Company believes it is not “more likely than not” to be realized in future periods. In addition, valuation allowance of $0.4 million was established in 2010 relating to stock compensation deferred tax assets.

To the extent the Company reports income in future periods, the Company 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 recognizes deferred tax assets and liabilities using tax rates in effect for the years in which temporary differences are expected to reverse, including net operating loss carryforwards. Management assesses the realizability of deferred tax assets and records a valuation allowance if it is more-likely-than-not that all or a portion of the deferred tax assets will not be realized. The Company considers the probability of future taxable income and our historical profitability, among other factors, in assessing the amount of the valuation allowance. Significant judgment is involved in this determination, including projections of future taxable income. Changes in these estimates and assumptions could materially affect the amount of valuation allowance. Adjustments could be required in the future if it is estimated that the amount of deferred tax assets that are "more-likely-than-not" able to be realized is more or less than the net amount recorded. Any change in the valuation allowance could have the effect of increasing and/or decreasing stockholders' equity or the income tax provision in the statement of comprehensive income (loss).

Uncertain tax positions.  The Company has identified its federal tax return and its state tax returns in Alabama, California, Florida, Georgia, Massachusetts, New York and North Carolina as material tax jurisdictions for purposes of calculating its uncertain tax positions.  The Company believes that its income tax filing positions and deductions through the period ended March 31, 2013 will not result in a material adverse effect on the Company's financial condition, results of operations or cash flow. The Company's policy for recording interest and penalties associated with audits is to record such items as a component of income tax expense. As of March 31, 2013, $0.7 million of interest and $0.8 million of penalties had been accrued.

There has been no change in the amount of unrecognized tax benefits for the three months ended March 31, 2013. Within the next twelve months, it is reasonably possible that approximately $1.0 million of the total uncertain tax positions recorded will reverse, primarily due to the expiration of statutes of limitation in various jurisdictions. 

13.  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 observable inputs other than quoted prices in active markets that are either directly or indirectly observable; and Level 3, defined as unobservable inputs for which little or no market data exists, therefore requiring an entity to develop its own assumptions.

16

EARTHLINK, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

UNAUDITED - (Continued)

Assets measured at fair value on a recurring basis

As of December 31, 2012 and March 31, 2013, 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 and marketable securities. The following tables present the Company’s assets that are measured at fair value on a recurring basis as of December 31, 2012 and March 31, 2013:

					Fair Value Measurements as of December 31, 2012 Using
Description	Carrying Value		Fair Value		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
	(in thousands)
Cash equivalents	$	27,854	$	27,854	$	27,854	$	—	$	—
Corporate debt securities	30,181		30,181		—		30,181		—
Government and agency securities	5,314		5,314		—		5,314		—
Commercial paper	9,293		9,293		—		9,293		—
Certificates of deposit	1,552		1,552		—		1,552		—
Municipal bonds	511		511		—		511		—
Total	$	74,705	$	74,705	$	27,854	$	46,851	$	—

					Fair Value Measurements as of March 31, 2013 Using
Description	Carrying Value		Fair Value		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
	(in thousands)
Cash equivalents	$	43,800	$	43,800	$	43,800	$	—	$	—
Corporate debt securities	31,412		31,412		—		31,412		—
Government and agency securities	5,188		5,188		—		5,188		—
Commercial paper	8,291		8,291		—		8,291		—
Municipal bonds	1,062		1,062		—		1,062		—
Total	$	89,753	$	89,753	$	43,800	$	45,953	$	—

As of December 31, 2012 and March 31, 2013, the Company classified its cash equivalents within Level 1 because these securities were valued based on quoted market prices in active markets. The Company classified its government and agency securities, corporate debt securities, commercial paper and certificates of deposit within Level 2 because these securities were valued based on quoted prices in markets that are less active, broker or dealer quotations or alternative pricing sources with reasonable levels of price transparency. The Company utilizes an independent pricing service to assist in obtaining fair-value pricing for its Level 2 securities.  Where observable market data is available, the pricing service will use a weighted average price from a variety of data providers.  Where observable market data is not readily available, the pricing service will use a pricing model appropriate to the type and structure of the security.  The Company periodically evaluates the reasonableness of these models.

17

EARTHLINK, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

UNAUDITED - (Continued)

Fair value of debt

The estimated fair values of the Company’s Senior Notes and ITC^DeltaCom Notes were determined based on Level 1 input using quoted prices in active markets. The following table presents the fair value of the Company’s debt, excluding capital leases, as of December 31, 2012 and March 31, 2013:

	As of December 31, 2012				As of March 31, 2013
	Carrying				Carrying
	Amount		Fair Value		Amount		Fair Value
	(in thousands)
ITC^DeltaCom senior notes	$	307,994	$	306,915	$	306,905	$	306,915
EarthLink senior notes	291,182		315,000		291,437		304,500
Total debt, excluding capital leases	$	599,176	$	621,915	$	598,342	$	611,415

14.  Segment Information

The Company reports segment information along the same lines that its chief executive officer reviews its operating results in assessing performance and allocating resources. The Company operates two reportable segments, Business Services and Consumer Services. The Company’s Business Services segment provides a broad range of data, voice and IT services to retail and wholesale business customers. The Company’s Consumer Services segment provides nationwide Internet access and related value-added services to residential customers.

The Company evaluates performance of its segments based on segment operating income. Segment operating income 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, operations expenses, product development expenses, certain technology and facilities expenses, billing operations and provisions for doubtful accounts. Segment operating income excludes other income and expense items and certain expenses over which segment managers do not have discretionary control. Costs excluded from segment operating income include various corporate expenses (consisting of certain costs such as corporate management, human resources, finance and legal), depreciation and amortization, impairment of goodwill and intangible assets, restructuring, acquisition and integration-related costs, and stock-based compensation expense, as they are not considered in the measurement of segment performance.

18

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, 2012 and 2013 is as follows:

	Three Months Ended
	March 31,
	2012		2013
	(in thousands)
Business Services
Revenues	$	260,264	$	247,791
Cost of revenues (excluding depreciation and amortization)	131,818		129,477
Gross margin	128,446		118,314
Direct segment operating expenses	86,024		86,003
Segment operating income	$	42,422	$	32,311
Consumer Services
Revenues	$	84,112	$	72,225
Cost of revenues (excluding depreciation and amortization)	27,519		24,947
Gross margin	56,593		47,278
Direct segment operating expenses	16,399		12,482
Segment operating income	$	40,194	$	34,796
Consolidated
Revenues	$	344,376	$	320,016
Cost of revenues	159,337		154,424
Gross margin	185,039		165,592
Direct segment operating expenses	102,423		98,485
Segment operating income	82,616		67,107
Depreciation and amortization	45,254		43,400
Impairment of goodwill	—		256,700
Restructuring, acquisition and integration-related costs	3,521		11,401
Corporate operating expenses	7,646		9,584
Income (loss) from operations	$	26,195	$	(253,978	)

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, 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.

19

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, 2012 and 2013 is as follows:

	Three Months Ended
	March 31,
	2012		2013
	(in thousands)
Business Services
Retail services	$	214,935	$	201,081
Wholesale services	36,942		38,858
Other services	8,387		7,852
Total revenues	260,264		247,791
Consumer Services
Access services	71,767		60,740
Value-added services	12,345		11,485
Total revenues	84,112		72,225
Total Revenues	$	344,376	$	320,016

The Company’s Business Services segment earns revenue by providing a broad range of data, voice and IT services to retail and wholesale business customers. The Company presents its Business Services revenue in the following three categories: (1) retail services, which includes data, voice and IT services provided to business customers; (2) wholesale services, which includes the sale of transmission capacity to other telecommunications carriers; and (3) other services, which includes the sale of customer premises equipment and web hosting. The Company's IT services, which are included within its retail services, include data centers, virtualization, security, applications, premises-based solutions, managed solutions and support services. Revenues generally consist of recurring monthly charges for such services; usage fees; installation fees; and termination fees.

The Company’s Consumer Services segment earns revenue by providing nationwide Internet access and related value-added services. The Company presents its Consumer Services revenue in the following two categories: (1) access services, which includes narrowband and broadband Internet access services and (2) value-added services, which includes revenues from ancillary services sold as add-on features to EarthLink’s Internet access services, such as security products, premium email only, home networking, email storage and Internet call waiting; search revenues; and advertising revenues. Revenues generally consist of recurring monthly charges for such services; usage fees; installation fees; termination fees; and fees for equipment.

15. Commitments and Contingencies

Legal proceedings and other disputes

General. The Company is party to various legal proceedings and other disputes arising in the normal course of business, including, but not limited to, regulatory audits, trademark and patent infringement, billing disputes, rights of access, tax, consumer protection, employment and tort. The Company accrues for such matters when it is both probable that a liability has been incurred and the amount of the loss can be reasonably estimated. Where it is probable that a liability has been incurred and there is a range of expected loss for which no amount in the range is more likely than any other amount, the Company accrues at the low end of the range. The Company reviews its accruals each reporting period.

The Company's management believes that there are no disputes, litigation or other legal proceedings, audits or disputes asserted or pending against the Company that could have, individually or in the aggregate, a material adverse effect on its financial position, results of operations or cash flows, and believes that adequate provision for any probable and estimable losses has been made in the Company's condensed consolidated financial statements. However, the ultimate result of any current or future litigation or other legal proceedings, audits or disputes is inherently unpredictable and could result in liabilities that are higher than currently predicted.

20

EARTHLINK, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

UNAUDITED - (Continued)

Regulatory audits. The Company is subject to regulatory audits in the ordinary course of business with respect to various matters, including audits by the Universal Service Administrative Company on universal service fund assessments and payments. These audits can cover periods for several years prior to the date the audit is undertaken and could result in the imposition of liabilities, interest and penalties if the Company's positions are not accepted by the auditing entity. The Company's financial statements contain reserves for certain of such potential liabilities.

Patents. From time to time, the Company receives notices of infringement of patent rights from parties claiming to own patents related to certain of the Company's services and products. While the Company has been subject to these disputes in the past, the number has increased since the acquisitions of ITC^DeltaCom and One Communications. Certain of these claims are made by patent holding companies that are not operating companies. The alleging parties generally seek royalty payments for prior use as well as future royalty streams. Most of these matters are in preliminary stages. The Company intends to vigorously defend its position with respect to all of these matters.

Billing disputes. The Company is periodically involved in disputes related to its billings to other carriers for access to its network. The Company does not recognize revenue related to such matters until the period that it is reasonably assured of the collection of these claims. In the event that a claim is made related to revenues previously recognized, the Company assesses the validity of the claim and adjusts the amount of revenue being recognized to the extent that the claim adjustment is considered probable and estimable.

     The Company periodically disputes network access charges that it is assessed by other companies with which the Company interconnects. The Company maintains adequate reserves for anticipated exposure associated with these billing disputes. The reserves are subject to changes in estimates and management judgment as new information becomes available. In view of the length of time historically required to resolve these disputes, they may be resolved or require adjustment in future periods and relate to costs invoiced, accrued or paid in prior periods. While the Company believes its reserves for billing disputes are adequate, the Company could record additional expense of up to $5.3 million for unrecorded disputed amounts.

 Regulation

The Company's services are subject to varying degrees of federal, state and local regulation. These regulations are subject to ongoing proceedings at federal and state administrative agencies or within state and federal judicial systems. Results of these proceedings could change, in varying degrees, the manner in which the Company operates. The Company cannot predict the outcome of these proceedings or their effect on the Company's industry generally or upon the Company specifically. 

16.  Condensed Consolidating Financial Information

The Company's Senior Notes are fully and unconditionally guaranteed, jointly and severally, on a senior unsecured basis by each of the Company’s existing and future domestic subsidiaries, other than (i) ITC^DeltaCom, Inc. and its subsidiaries and (ii) certain other excluded subsidiaries (the “Guarantor Subsidiaries”). ITC^DeltaCom, Inc. and its subsidiaries are not guarantors of the Senior Notes (the “Non-Guarantor Subsidiaries”). All of the Guarantor Subsidiaries are 100% owned by the Company. As a result of these guarantees, the Company is required to provide the financial information set forth under Rule 3-10 of Regulation S-X, “Financial Statements of Guarantors and Issuers of Guaranteed Securities Registered or Being Registered” (“Rule 3-10”).

The accompanying condensed consolidating financial information has been prepared and presented pursuant to Rule 3-10. The Parent column represents EarthLink’s stand-alone results and its investment in all of its subsidiaries presented using the equity method of accounting. The Guarantor Subsidiaries and the Non-Guarantor Subsidiaries are presented in separate columns and represent all the applicable subsidiaries on a combined basis. Intercompany eliminations are shown in a separate column. Certain amounts in the prior period condensed consolidating balance sheet and condensed consolidating statement of comprehensive loss have been reclassified to conform with the current period presentation as a result of presenting the information of subsidiaries on a stand-alone basis.

The condensed consolidating financial information is presented in the following tables (in thousands):

21

EARTHLINK, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

UNAUDITED - (Continued)

Condensed Consolidating Balance Sheet

As of March 31, 2013

	Parent			Guarantor Subsidiaries			Non-Guarantor Subsidiaries			Consolidations & Eliminations			Consolidated
ASSETS
Current assets:
Cash and cash equivalents	$	104,481		$	6,045		$	35,622		$	—		$	146,148
Marketable securities	41,845			—			—			—			41,845
Restricted cash	—			—			1,013			—			1,013
Accounts receivable, net	9,014			58,112			42,827			—			109,953
Prepaid expenses	5,577			8,586			4,860			—			19,023
Deferred income taxes, net	(445		)	4,412			—			5,935			9,902
Due from affiliates	93,582			6,821			—			(100,403		)	—
Other current assets	4,389			11,298			8,878			(523		)	24,042
Total current assets	258,443			95,274			93,200			(94,991		)	351,926
Long-term marketable securities	4,108			—			—			—			4,108
Property and equipment, net	25,753			181,586			223,589			—			430,928
Long-term deferred income taxes, net	(9,347		)	89,900			—			152,320			232,873
Goodwill	88,920			95,805			194,690			(256,700		)	122,715
Purchased intangible assets, net	—			111,777			87,669			—			199,446
Investment in subsidiaries	672,600			—			—			(672,600		)	—
Other long-term assets	8,633			9,569			1,032			523			19,757
Total assets	$	1,049,110		$	583,911		$	600,180		$	(871,448	)	$	1,361,753
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Accounts payable	$	3,043		$	8,601		$	5,627		$	—		$	17,271
Accrued payroll and related expenses	3,761			11,950			7,081			—			22,792
Other accrued liabilities	36,522			57,266			49,726			—			143,514
Deferred revenue	13,502			20,060			17,725			—			51,287
Due to affiliates	—			89,387			11,016			(100,403		)	—
Current portion of debt and capital lease obligations	87			1,079			233			—			1,399
Total current liabilities	56,915			188,343			91,408			(100,403		)	236,263
Long-term debt and capital lease obligations	291,766			14,766			307,134			—			613,666
Other long-term liabilities	3,218			22,568			6,669			—			32,455
Total liabilities	351,899			225,677			405,211			(100,403		)	882,384
Stockholders’ equity:
Common stock	1,972			—			—			—			1,972
Additional paid-in capital	2,054,950			635,421			255,612			(891,033		)	2,054,950
Accumulated deficit	(624,721		)	(277,187		)	(60,643		)	119,988			(842,563		)
Treasury stock, at cost	(735,003		)	—			—			—			(735,003		)
Accumulated other comprehensive income	13			—			—			—			13
Total stockholders’ equity	697,211			358,234			194,969			(771,045		)	479,369
Total liabilities and stockholders’ equity	$	1,049,110		$	583,911		$	600,180		$	(871,448	)	$	1,361,753

22

EARTHLINK, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

UNAUDITED - (Continued)

Condensed Consolidating Balance Sheet

As of December 31, 2012

	Parent			Guarantor Subsidiaries			Non-Guarantor Subsidiaries			Consolidations & Eliminations			Consolidated
ASSETS
Current assets:
Cash and cash equivalents	$	70,312		$	54,969		$	32,340		$	—		$	157,621
Marketable securities	42,073			—			—			—			42,073
Restricted cash	—			—			1,013			—			1,013
Accounts receivable, net	9,490			60,623			42,652			—			112,765
Prepaid expenses	6,352			6,804			4,015			—			17,171
Deferred income taxes, net	1,234			5,932			—			8,788			15,954
Due from affiliates	90,778			25,715			4,714			(121,207		)	—
Other current assets	7,862			7,520			4,921			—			20,303
Total current assets	228,101			161,563			89,655			(112,419		)	366,900
Long-term marketable securities	4,778			—			—			—			4,778
Property and equipment, net	24,427			175,805			218,734			—			418,966
Long-term deferred income taxes, net	12,421			71,656			—			110,935			195,012
Goodwill	88,920			95,805			194,690			—			379,415
Purchased intangible assets, net	—			120,505			94,180			—			214,685
Investment in subsidiaries	695,175			—			—			(695,175		)	—
Other long-term assets	8,842			9,969			843			—			19,654
Total assets	$	1,062,664		$	635,303		$	598,102		$	(696,659	)	$	1,599,410
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Accounts payable	$	2,654		$	7,812		$	8,326		$	—		$	18,792
Accrued payroll and related expenses	9,493			13,221			8,289			—			31,003
Other accrued liabilities	23,064			61,266			45,242			—			129,572
Deferred revenue	13,883			20,172			17,635			—			51,690
Due to affiliates	—			121,207			—			(121,207		)	—
Current portion of debt and capital lease obligations	93			1,023			259			—			1,375
Total current liabilities	49,187			224,701			79,751			(121,207		)	232,432
Long-term debt and capital lease obligations	291,534			15,086			308,270			—			614,890
Other long-term liabilities	3,139			22,679			7,466			—			33,284
Total liabilities	343,860			262,466			395,487			(121,207		)	880,606
Stockholders’ equity:
Common stock	1,969			—			—			—			1,969
Additional paid-in capital	2,057,974			634,388			254,289			(888,677		)	2,057,974
Accumulated deficit	(606,148		)	(261,551		)	(51,674		)	313,225			(606,148		)
Treasury stock, at cost	(735,003		)	—			—			—			(735,003		)
Accumulated other comprehensive income	12			—			—			—			12
Total stockholders’ equity	718,804			372,837			202,615			(575,452		)	718,804
Total liabilities and stockholders’ equity	$	1,062,664		$	635,303		$	598,102		$	(696,659	)	$	1,599,410

23

EARTHLINK, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

UNAUDITED - (Continued)

Condensed Consolidating Statement of Comprehensive Loss

Three Months Ended March 31, 2013

	Parent			Guarantor Subsidiaries			Non-Guarantor Subsidiaries			Consolidations & Eliminations			Consolidated
Revenues	$	77,102		$	139,960		$	105,186		$	(2,232	)	$	320,016
Operating costs and expenses:
Cost of revenues (exclusive of depreciation and amortization shown separately below)	26,216			80,477			49,963			(2,232		)	154,424
Selling, general and administrative (exclusive of depreciation and amortization shown separately below)	22,065			50,224			35,780			—			108,069
Depreciation and amortization	1,620			23,856			17,924			—			43,400
Impairment of goodwill	—			—			—			256,700			256,700
Restructuring, acquisition and integration-related costs	3,552			4,234			3,615			—			11,401
Total operating costs and expenses	53,453			158,791			107,282			254,468			573,994
Income (loss) from operations	23,649			(18,831		)	(2,096		)	(256,700		)	(253,978		)
Interest expense and other, net	(6,729		)	(968		)	(6,859		)	—			(14,556		)
Equity in losses of subsidiaries	(24,605		)	—			—			24,605			—
Loss before income taxes	(7,685		)	(19,799		)	(8,955		)	(232,095		)	(268,534		)
Income tax (provision) benefit	(10,888		)	4,163			(14		)	38,858			32,119
Net loss	$	(18,573	)	$	(15,636	)	$	(8,969	)	$	(193,237	)	$	(236,415	)
Comprehensive loss	$	(18,572	)	$	(15,636	)	$	(8,969	)	$	(193,237	)	$	(236,414	)

Condensed Consolidating Statement of Comprehensive Income (Loss)

Three Months Ended March 31, 2012

	Parent			Guarantor Subsidiaries			Non-Guarantor Subsidiaries			Consolidations & Eliminations			Consolidated
Revenues	$	89,893		$	144,348		$	111,955		$	(1,820	)	$	344,376
Operating costs and expenses:
Cost of revenues (exclusive of depreciation and amortization shown separately below)	29,014			77,603			54,540			(1,820		)	159,337
Selling, general and administrative (exclusive of depreciation and amortization shown separately below)	24,042			52,412			33,615			—			110,069
Depreciation and amortization	1,925			26,000			17,329			—			45,254
Restructuring, acquisition and integration-related costs	1,786			1,461			274			—			3,521
Total operating costs and expenses	56,767			157,476			105,758			(1,820		)	318,181
Income (loss) from operations	33,126			(13,128		)	6,197			—			26,195
Interest expense and other, net	(6,474		)	(1,769		)	(7,515		)	—			(15,758		)
Equity in losses of subsidiaries	(11,191		)	—			—			11,191			—
Income (loss) before income taxes	15,461			(14,897		)	(1,318		)	11,191			10,437
Income tax (provision) benefit	(9,414		)	5,148			(124		)	1,216			(3,174		)
Net income (loss)	$	6,047		$	(9,749	)	$	(1,442	)	$	12,407		$	7,263
Comprehensive income (loss)	$	6,061		$	(9,749	)	$	(1,442	)	$	12,407		$	7,277

24

EARTHLINK, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

UNAUDITED - (Continued)

Condensed Consolidating Statement of Cash Flows

Three Months EndedMarch 31, 2013

	Parent			Guarantor Subsidiaries			Non-Guarantor Subsidiaries			Consolidations & Eliminations		Consolidated
Cash flows from operating activities	$	35,541		$	(27,076	)	$	23,379		$	—	$	31,844
Cash flows from investing activities:
Purchases of property and equipment	(2,043		)	(20,388		)	(20,023		)	—		(42,454		)
Purchases of marketable securities	(15,792		)	—			—			—		(15,792		)
Sales and maturities of marketable securities	16,690			—			—			—		16,690
Purchase of customer relationships	—			(1,195		)	—			—		(1,195		)
Net cash used in investing activities	(1,145		)	(21,583		)	(20,023		)	—		(42,751		)
Cash flows from financing activities:
Principal payments under capital lease obligations	(28		)	(265		)	(88		)	—		(381		)
Payment of dividends	(199		)	—			—			—		(199		)
Other	—			—			14			—		14
Net cash used in financing activities	(227		)	(265		)	(74		)	—		(566		)
Net increase (decrease) in cash and cash equivalents	34,169			(48,924		)	3,282			—		(11,473		)
Cash and cash equivalents, beginning of period	70,312			54,969			32,340			—		157,621
Cash and cash equivalents, end of period	$	104,481		$	6,045		$	35,622		$	—	$	146,148

Condensed Consolidating Statement of Cash Flows

Three Months EndedMarch 31, 2012

	Parent			Guarantor Subsidiaries			Non-Guarantor Subsidiaries			Consolidations & Eliminations		Consolidated
Cash flows from operating activities	$	24,748		$	16,817		$	24,646		$	—	$	66,211
Cash flows from investing activities:
Purchases of property and equipment	(4,316		)	(12,882		)	(14,577		)	—		(31,775		)
Purchases of marketable securities	(19,187		)	—			—			—		(19,187		)
Change in restricted cash	—			—			718			—		718
Other	16			15			1			—		32
Net cash used in investing activities	(23,487		)	(12,867		)	(13,858		)	—		(50,212		)
Cash flows from financing activities:
Repayment of debt and capital lease obligations	(9		)	(276		)	(130		)	—		(415		)
Payment of dividends	(5,441		)	—			—			—		(5,441		)
Proceeds from exercises of stock options	46			—			—			—		46
Change in due to/from affiliates, net	(8,006		)	8,006			—			—		—
Other	—			—			31			—		31
Net cash (used in) provided by financing activities	(13,410		)	7,730			(99		)	—		(5,779		)
Net (decrease) increase in cash and cash equivalents	(12,149		)	11,680			10,689			—		10,220
Cash and cash equivalents, beginning of period	148,363			28,490			34,930			—		211,783
Cash and cash equivalents, end of period	$	136,214		$	40,170		$	45,619		$	—	$	222,003

25

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 “Cautionary Note Concerning Factors That May Affect Future Results” in this Item 2.

Management's Discussion and Analysis of Financial Condition and Results of Operations is intended to provide a reader of our financial statements with a narrative from the perspective of management. The following Management’s Discussion and Analysis 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, 2012. Management's Discussion and Analysis of Financial Condition and Results of Operations is presented in the following sections:

• Overview

• Consolidated Results of Operations

• Segment Results of Operations

• Liquidity and Capital Resources

• Non-GAAP Financial Measures

• Cautionary Note Regarding Factors That May Affect Future Results

Overview

EarthLink, Inc. (“EarthLink” or the “Company”), together with its consolidated subsidiaries, is a leading network, communications and IT services provider to business and residential customers in the United States. We operate two reportable segments, Business Services and Consumer Services. Our Business Services segment provides a broad range of data, voice, equipment and IT services to retail and wholesale business customers. Our Consumer Services segment provides nationwide Internet access and related value-added services to residential customers. We operate an extensive network including approximately 29,400 route miles of fiber, 90 metro fiber rings and eight enterprise-class data centers that provide IP coverage across more than 90 percent of the United States.

First Quarter 2013 Highlights

• Total revenues were $320.0 million, a 7% decrease compared to the three months ended March 31, 2012, consisting

of a $12.5 million decrease in Business Services revenue and a $11.9 million decrease in Consumer Services revenue

• Net loss was $236.4 million, compared to net income of $7.3 million during the three months ended March 31, 2012 (net loss during the three months ended March 31, 2013 includes a pre-tax non-cash goodwill impairment charge of $256.7 million)

• Adjusted EBITDA (a non-GAAP measure, see “Non-GAAP Financial Measures” in this Item 2) was $61.5 million, a decrease from $77.6 million during the three months ended March 31, 2012 due to the decrease in total revenues and an increase in costs to grow our Business Services, offset by cost synergies from integrating acquisitions

• Net cash provided by operating activities was $31.8 million for the three months ended March 31, 2013, a decrease from $66.2 million during the comparable period in 2012

• Unlevered free cash flow (a non-GAAP measure, see “Non-GAAP Financial Measures” in this Item 2) was $19.0 million during the three months ended March 31, 2013, a decrease from $45.9 million during the three months ended March 31, 2012

• Cash used in investing activities and cash used in financing activities were $42.8 million and $0.6 million, respectively, for the three months ended March 31, 2013, compared to cash used in investing activities and cash used in financing activities of $50.2 million and $5.8 million, respectively, during the three months ended March 31, 2012

26

Business Strategy

Our business strategy is to continue our transformation into a nationwide provider of communications and IT services for the mid-market business customer. We believe IT services is an emerging market with significant opportunity for growth, and we are positioning EarthLink to be a trusted partner in the small and medium-sized enterprise marketplace for businesses with IT and network security needs. The key elements of our business strategy are as follows:

• Offer a complete package of communications and IT services products. We provide a nationwide suite of business voice, data and IT services. We are focused on continuing to broaden our suite of products and services to offer a complete package of network connectivity and IT services and to design and implement solutions to address the evolving business and infrastructure needs of our customers. We are currently investing capital to extend our core fiber IP network, expand our IT solutions footprint with additional data centers and launch a next generation cloud hosting platform.

• Increase revenues from growth products and services. Revenues from our legacy products and services have been declining due to economic, competitive, technological and regulatory developments and we expect these revenues to continue to decline. We are focused on managing this decline by executing on opportunities to leverage these customer relationships by migrating these customers to our growth products. We believe our growth products are MPLS, hosted voice and IT services. We are focused on growing revenues for these products by enhancing our sales force efforts and increasing brand awareness for our IT services. We are also focused on growing our wholesale services as we capitalize on unique fiber routes within our footprint.

• Provide a superior customer experience. We are committed to providing high-quality customer service and continuing to monitor customer satisfaction in all facets of our business. We believe focusing on the customer relationship increases loyalty and reduces churn. We believe that our broad communications and IT services portfolio and blend of access technologies for connectivity are key differentiators that can help us build long-term customer relationships. We bring these services together through our myLink^TM self-service customer control point where users can access all of their EarthLink Business services via one interface. We are focused on creating a customer-focused organization that will provide a consistent nationwide approach to offering and supporting EarthLink products and services.

• Successfully integrate acquisitions. We are focused on successfully integrating our acquisitions in order to realize synergies and cost benefits. To date, we have functionally aligned employees across the organization, launched a nationwide product and IT services portfolio, implemented a common financial system and consolidated and integrated network operations centers, sales platforms and certain billing platforms. We are currently integrating our operating support system and certain other billing systems. We believe that our competitive positioning with current and existing customers will be strengthened by our ability to continue to successfully integrate past and other potential acquisitions.

• Selectively pursue potential strategic acquisitions. We will continue to selectively evaluate and consider potential strategic transactions that we believe will complement and grow our business. Our acquisition strategy may include investments or acquisitions of new product and services capabilities, network assets or business customers to achieve greater national scale.

Challenges and Risks

The primary challenge we face in executing our business strategy to successfully transition into a national communications and IT services provider is to grow revenues from our evolving Business Services product portfolio on a timely basis to offset declining revenues from other Business Services products and from our Consumer Services segment. Contributing to this challenge are the following: providing products and services that meet changing customer needs on a timely and cost-effective basis, responding to competitive and economic pressures, managing the rate of decline in certain revenue streams, successfully integrating our acquisitions to achieve expected synergies and cost savings, implementing operating efficiencies and adapting to regulatory changes and initiatives.  Our future success for growth depends on the timing and market acceptance of our new products and services, our ability to market our services in a cost-effective manner to new customers, our ability to differentiate our services from those of our competitors, our ability to maintain and expand our sales to existing customers, our ability to strengthen awareness of our brand, our ability to provide quality implementation and customer support for these products and the reliability and quality of our services.  The factors we believe are instrumental to the achievement of our business strategy may be subject to competitive, regulatory and other events and circumstances that are beyond our control. For a more detailed list of all risks and uncertainties inherent in our business, please refer to the detailed cautionary statements and risk factors referred to under “Risk Factors” in Item 1A of Part II and under “Cautionary Note Concerning Factors That May Affect Future Results” in this Item 2.

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Trends in our Business

Our financial results are impacted by several significant trends, which are described below.

Industry factors. We operate in the communications and IT services industry, which is characterized by intense competition, industry consolidation resulting in larger competitors, an evolving regulatory environment, changing technology and changes in customer needs.  We expect these trends to continue. In addition, merger and acquisition transactions and other factors have reduced the number of vendors from which we may purchase network elements that we leverage to operate our business.

Legacy business services revenues. Our legacy business service revenues, specifically traditional voice services, have been declining due to competitive pressures and changes in the industry, and we expect this trend to continue. Churn has been improving, but the rate of new customer bookings of legacy products has not consistently kept up with expectations. In addition, revenues have been adversely impacted as a result of rules adopted by the FCC in late 2011 regarding intercarrier compensation. The rules include the elimination of terminating switched access rates and other per-minute terminating charges between service providers by 2018, through annual reductions in the rates. To counteract trends in our legacy Business Services revenues, we are focused on building long-term customer relationships, offering a diverse portfolio of IT services and investing in additional data centers, our fiber network and our next generation cloud services. We are also taking steps to lower the cost structure of our legacy Business Services. In January 2013, we decided to exit telecom systems sales after the first half of 2013, which was a low margin, non-recurring revenue stream. This will allow us to focus on our hosted VoIP products.

IT services. The industry for cloud, managed security and IT services is relatively new and continues to evolve. The IT services market is growing as security needs, compliance requirements and IT costs increase. IT services currently represents the smallest proportion of our Business Services revenues. However, we believe this represents a significant growth area for our business and there is opportunity for EarthLink to address this market nationally for small and medium-sized enterprises. As a result, we are taking steps to accelerate our transition into an IT services company. In January 2013, we restructured our sales organization to better meet the needs of the IT services market. Specifically, we are focusing on larger geographic markets where there are more customers with a propensity to buy IT services, increasing our efforts in Search Engine Marketing to drive leads for our inside sales force, increasing brand awareness for our IT services and adding additional technical talent in the field to support our IT services sales efforts.

Economic conditions. Many of our existing and target customers are small and medium-sized businesses. We believe these businesses are more likely to be affected by economic downturns than larger, more established businesses. We believe that the financial and economic pressures faced by our customers in this environment of diminished consumer spending, corporate downsizing and tightened credit have had, and may continue to have, an adverse effect on our results of operations, including longer sales cycles and increased customer demands for price reductions in connection with contract renewals. Additionally, our consumer access services are discretionary and dependent upon levels of consumer spending. Unfavorable economic conditions could cause customers to slow spending in the future, which could adversely affect our revenues and churn.

Consumer access declines. Our consumer access subscriber base and revenues have been declining and are expected to continue to decline due to the continued maturation of the market for Internet access and competitive pressures in the industry. In addition, we have implemented, and expect to continue to implement, targeted price increases, which could negatively impact our churn rates. The mix of our consumer access subscriber base has been shifting from narrowband access to broadband access customers. Consumer broadband access revenues have lower gross margins than narrowband revenues due to the costs associated with delivering broadband services. This change in mix has negatively affected our profitability and we expect this trend to continue. To counteract trends in our consumer revenues, we are focused on customer retention, operational efficiency and adding customers through marketing channels that we believe will produce an acceptable rate of return.

Revenue Sources

Business Services. Our Business Services segment earns revenue by providing a broad range of data, voice and IT services to retail and wholesale business customers. We present our Business Services revenue in the following three categories: (1) retail services, which includes data, voice and IT services provided to business customers; (2) wholesale services, which includes the sale of transmission capacity to other telecommunications carriers; and (3) other services, which includes the sale of customer premises equipment and web hosting. Our IT services, which are included within our retail services, include data centers, virtualization, security, applications, premises-based solutions, managed solutions and support services. Revenues generally consist of recurring monthly charges for such services; usage fees; installation fees; and termination fees.

Consumer Services. Our Consumer Services segment earns revenue by providing nationwide Internet access and related value-added services to residential customers. We present our Consumer Services in two categories: (1) access services, which

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includes narrowband access services and broadband access services; and (2) value-added services, which includes revenues from ancillary services sold as add-on features to EarthLink’s Internet access services, such as security products, premium email only, home networking and email storage; search revenues; and advertising revenues. Revenues generally consist of recurring monthly charges for such services; usage fees; installation fees; termination fees; and equipment fees.

Consolidated Results of Operations

The following table sets forth statement of operations data for the three months ended March 31, 2012 and 2013:

	Three Months Ended
	March 31,
	2012			2013
	(in thousands)
Revenues	$	344,376		$	320,016
Operating costs and expenses:
Cost of revenues (exclusive of depreciation and amortization shown separately below)	159,337			154,424
Selling, general and administrative (exclusive of of depreciation and amortization shown separately below)	110,069			108,069
Depreciation and amortization	45,254			43,400
Impairment of goodwill	—			256,700
Restructuring, acquisition and integration-related costs	3,521			11,401
Total operating costs and expenses	318,181			573,994
Income (loss) from operations	26,195			(253,978		)
Interest expense and other, net	(15,758		)	(14,556		)
Income (loss) before income taxes	10,437			(268,534		)
Income tax (provision) benefit	(3,174		)	32,119
Net income (loss)	$	7,263		$	(236,415	)

Revenues

The following table presents revenues by groups of similar services and by segment for the three months ended March 31, 2012 and 2013:

	Three Months Ended March 31,								Change
			% of				% of
	2012		Total		2013		Total		Dollars			Percent
	(dollars in thousands)
Business Services
Retail services	$	214,935	83	%	$	201,081	81	%	$	(13,854	)	(6	)%
Wholesale services	36,942		14	%	38,858		16	%	1,916			5	%
Other	8,387		3	%	7,852		3	%	(535		)	(6	)%
Total revenues	260,264		100	%	247,791		100	%	(12,473		)	(5	)%
Consumer Services
Access services	71,767		85	%	60,740		84	%	(11,027		)	(15	)%
Value-added services	12,345		15	%	11,485		16	%	(860		)	(7	)%
Total revenues	84,112		100	%	72,225		100	%	(11,887		)	(14	)%
Total revenues	$	344,376			$	320,016			$	(24,360	)	(7	)%

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Business Services

Our Business Services segment earns revenue by providing a broad range of data, voice and IT services to retail and wholesale business customers. Revenues generally consist of recurring monthly charges for such services; usage fees; installation fees; and termination fees. Total Business Services revenue decreased $12.5 million during the three months ended March 31, 2013 compared to the prior year period, as further discussed below.

We expect continued declines in Business Services revenues from traditional voice services and other legacy products, including a decline as a result of our decision to exit sales of legacy voice equipment after the first half of 2013, which will negatively impact Business Services revenues in 2013. Business Services revenues will also be adversely impacted as a result of the rules adopted by the FCC regarding intercarrier compensation. In addition, growth in our Business Services revenues may be adversely impacted by longer than anticipated sales cycles and installations of our more advanced products, competition, regulatory changes, timing and market acceptance of our new products and services, shifting patterns of use, convergence of technology and general economic conditions. However, to counteract these pressures, we continue to emphasize our diverse portfolio of communications and IT services and are focused on growing our suite of IT services. As a result, we expect the mix of our retail Business Service revenues to change over time, from legacy services to IT services. We are also focused on growing our wholesale services as we capitalize on unique fiber routes within our footprint.

Retail Services. Retail services include data, voice and IT services (including data centers, virtualization, security, applications, premises-based solutions, managed solutions and support services) provided to business customers. The following table presents the primary reasons for the change in Business Services retail revenues for the three months ended March 31, 2013 compared to the prior year period:

	Three Months Ended
	March 31, 2013
	(in millions)
Due to decline in legacy products (a)	$	(20.1	)
Due to growth products (b)	4.8
Due to IT services product launches (c)	1.5
Total change in retail services revenues	$	(13.8	)

______________

(a) Decrease due to decline in certain legacy products, including traditional voice, lower-end, single site broadband services and web hosting. Revenues for these legacy products have been decreasing due to competition in the industry, the migration of customers to more advanced services and a decreased emphasis on selling these services

(b) Increase due to sales of growth products, including MultiProtocol Label Switching ("MPLS") and hosted Voice-over-Internet Protocol (“VoIP”)

(c) Increase due to new IT services product launches over the past year

Wholesale Services. Wholesale services includes the sale of transmission capacity to other telecommunications carriers. The increase in wholesale services revenues during the three months ended March 31, 2013 compared to the prior year period was primarily due to $1.2 million favorable adjustment recognized during the three months ended March 31, 2013 associated with the One Communications acquisition. During the three months ended March 31, 2013, an arbitrator made a final decision with respect to post-closing working capital adjustments relating to the acquisition.

Other Services. Other services includes the sale of customer premises equipment and web hosting. The decrease in other services revenues during the three months ended March 31, 2013 compared to the prior year period was primarily due to a decrease in legacy web hosting revenues. Also contributing to the decrease was a reduction in the volume of customer premise equipment sold.

Consumer Services

Access services. Access services include narrowband access services (including traditional, fully-featured narrowband access and value-priced narrowband access) and broadband access services (including high-speed access via DSL and cable and VoIP). Access service revenues consist of recurring monthly charges for narrowband and broadband access services; usage fees; installation fees; termination fees; and fees for equipment.

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The decrease in consumer access revenues was due to a decrease in narrowband access and broadband access revenues. This was primarily due to a decrease in average consumer access subscribers, which decreased from 1.3 million during the three months ended March 31, 2012 to 1.1 million during the three months ended March 31, 2013.  The decrease in average consumer access subscribers resulted from limited sales and marketing activities, the continued maturation of and competition in the market for narrowband Internet access and competitive pressures in the industry. However, we continue to focus on the retention of customers and on marketing channels that we believe will produce an acceptable rate of return.

Our monthly consumer subscriber churn rates decreased from 2.5% during the three months ended March 31, 2012 to 2.2% during the three months ended March 31, 2013, which moderated the decline in average consumer subscribers. Churn rates decreased due to the increased tenure of our consumer subscriber base.

We expect our consumer access and service subscriber base and revenues to continue to decrease due to limited sales and marketing activities, competition from cable, DSL and wireless providers, declines in gross broadband subscriber additions and the continued maturation of the market for narrowband Internet access. However, we expect the rate of churn and revenue decline to continue to remain stable as our customer base becomes longer tenured and churn rates go down. Consistent with trends in the Internet access industry, we expect the mix of our consumer access subscriber base to continue to shift from narrowband access to broadband access customers.

Value-added services revenues. Value-added services revenues consist of revenues from ancillary services sold as add-on features to our Internet access services, such as security products, premium email only, home networking and email storage; search revenues; and advertising revenues.We derive these revenues from fees charged for ancillary services; fees generated through revenue sharing arrangements with online partners whose products and services can be accessed through our web properties, such as the Google™ search engine; and fees charged for advertising on our various web properties.

The decrease in value-added services revenues was due primarily to a decrease in revenues from our security and home networking services and a decrease in search and advertising revenues. These decrease were attributable to the overall decline in average consumer subscribers.

Cost of revenues

The following table presents cost of revenues by segment for the three months ended March 31, 2012 and 2013:

	Three Months Ended
	March 31,				Change
	2012		2013		Dollar			Percent
	(dollars in thousands)
Business Services	$	131,818	$	129,477	$	(2,341	)	(2)%
Consumer Services	27,519		24,947		(2,572		)	(9)%
Total cost of revenues	$	159,337	$	154,424	$	(4,913	)	(3)%

Business Services

Cost of revenues for our Business Services segment primarily consists of the cost of connecting customers to our networks via leased facilities; the costs of leasing components of our network facilities; costs paid to third-party providers for interconnect access and transport services; the costs of providing IT services; and the cost of equipment sold to customers.

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The following table presents the primary reasons for the change in Business Services cost of revenues for the three months ended March 31, 2013 compared to the prior year period:

	Three Months Ended
	March 31, 2013
	(in millions)
Due to decline in legacy products (a)	$	(2.6	)
Due to reduction of IRU liability (b)	(1.8		)
Due to favorable One Communications settlement (c)	(0.9		)
Due to IT services product launches (d)	3.0
Total change in Business Services cost of revenues	$	(2.3	)

______________

(a) Decrease due to decline in certain legacy products, including traditional voice, lower-end, single site broadband services and web hosting, partially offset by sales of growth products which include MPLS and hosted VoIP

(b) Decrease due to the renegotiation of an IRU agreement recorded as a liability in purchase accounting for ITC^DeltaCom

(c) Decrease due to a favorable adjustment recognized during the three months ended March 31, 2013 for an arbitrator's final decision with respect to post-closing working capital adjustments relating to the One Communications acquisition

(d) Increase due to IT services product launches over the past year

Consumer Services

Cost of revenues for our Consumer Services segment primarily consists of telecommunications fees and network operations costs incurred to provide our Internet access services; fees paid to suppliers of our value-added services; fees paid to content providers for information provided on our online properties; and the cost of equipment sold to customers for use with our services. Cost of revenues for our Consumer Services segment also include sales incentives, which include the cost of promotional products and services provided to potential and new subscribers, including free modems and other hardware. Our principal provider for narrowband services is Level 3 Communications, Inc. We also purchase lesser amounts of narrowband services from certain regional and local providers. Our principal providers of broadband connectivity are AT&T Inc., Bright House Networks, CenturyLink, Inc., Comcast Corporation, Megapath, Time Warner Cable and Verizon Communications, Inc. Many of our agreements have a short term or operate on a month-to-month basis. We cannot be certain of renewal or non-termination of our contracts or that legislative or regulatory factors will not affect our contracts. In addition, Level 3 Communications, Inc. is planning on decommissioning its managed modem network at the end of 2013 and we will have to transition customers to other narrowband providers.

The decrease in Consumer Services cost of revenues compared to the prior year period was primarily due to the decline in average consumer services subscribers. Partially offsetting this decrease was an increase due to the shift in mix from narrowband to broadband customers.

We expect Consumer Services segment cost of revenues to continue to decrease as a result of declines in average consumer subscribers. Consistent with trends in the Internet access industry, we expect the mix of our consumer access subscriber base to continue to shift from narrowband access to broadband access customers, which will negatively affect our Consumer Services segment cost of revenues due to the higher costs associated with delivering broadband services.

Selling, general and administrative

The following table presents our selling, general and administrative expenses for the three months ended March 31, 2012 and 2013: 

	Three Months Ended
	March 31,				Change
	2012		2013		Dollar			Percent
	(dollars in thousands)
Selling, general and administrative expenses	$	110,069	$	108,069	$	(2,000	)	(2)%

Selling, general and administrative expenses consist of expenses related to sales and marketing, customer service, network operations, information technology, regulatory, billing and collections, corporate administration, and legal and accounting. Such

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costs include salaries and related employee costs (including stock-based compensation), outsourced labor, professional fees, property taxes, travel, insurance, occupancy costs, advertising and other administrative expenses.

The following table presents the primary reasons for the change in selling, general and administrative expenses for the three months ended March 31, 2013 compared to the prior year period:

	Three Months Ended
	March 31, 2013
	(in millions)
Due to decline in people-related costs (a)	$	(5.2	)
Due to favorable One Communications settlement (b)	(1.1		)
Due to increase in reserves for loss contingencies (c)	3.0
Due to increase in stock-based compensation (d)	1.3
Total change in Business Services cost of revenues	$	(2.0	)

______________

(a) Decrease due to decline in people costs resulting from reduction in headcount over the past year and synergies from integrating our businesses

(b) Decrease due to a favorable adjustment recognized during the three months ended March 31, 2013 for an arbitrator's final decision with respect to post-closing working capital adjustments relating to the One Communications acquisition

(c) Increase due to additional reserves for loss contingencies recorded during the three months ended March 31, 2013

(d) Increase in stock-based compensation expense due to an increase in grants over the past year and additional costs related to our 2013 annual bonus plan as certain employees will receive a portion of their 2013 bonus in restricted stock units.

We expect that selling, general and administrative expenses will increase as we seek to grow our business services revenue. However, we expect to realize cost synergies as we integrate our acquisitions. We will continue to seek operating efficiencies, such as consolidating operations and integrating systems, though certain of these synergies may take longer or present greater costs to realize than originally anticipated.

Depreciation and amortization

The following table presents our depreciation and amortization expense for the three months ended March 31, 2012 and 2013:

	Three Months Ended
	March 31,				Change
	2012		2013		Dollars			Percent
	(dollars in thousands)
Depreciation expense	$	27,574	$	26,966	$	(608	)	(2)%
Amortization expense	17,680		16,434		(1,246		)	(7)%
Total	$	45,254	$	43,400	$	(1,854	)	(4)%

Depreciation and amortization includes depreciation of property and equipment and amortization of definite-lived intangible assets acquired in purchases of businesses and purchases of customer bases from other companies. Property and equipment is depreciated using the straight-line method over the estimated useful lives of the various asset classes. Leasehold improvements are depreciated using the straight-line method over the shorter of the estimated useful life or the remaining term of the lease. Definite-lived intangible assets, which primarily consist of subscriber bases and customer relationships, acquired software and technology, trade names and other assets, are amortized on a straight-line basis over their estimated useful lives, which range from three to six years.

The decrease in depreciation and amortization expense during the three months ended March 31, 2013 compared to the prior year period was primarily due to definite-lived intangible assets becoming fully amortized over the past year and property and equipment becoming fully depreciated over the past year.

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Impairment of goodwill

During the three months ended March 31, 2013, we recognized a $256.7 million non-cash impairment charge to goodwill related to our Business Services reporting unit. The impairment was based on an analysis of a number of factors after a decline in our market capitalization following the announcement of our fourth quarter 2012 earnings and 2013 financial guidance. The primary factor contributing to the impairment was a change in the discount rate and market multiples as a result of the change in these market conditions, both key assumptions used in the determination of fair value.

We test our goodwill annually during the fourth quarter of each fiscal year or when events or changes in circumstances indicate that goodwill might be impaired. Our stock price and market capitalization declined during the three months ended March 31, 2013 following the announcement in mid-February 2013 of our fourth quarter 2012 earnings and 2013 financial guidance. As a result of the sustained decrease in stock price and market capitalization, we performed an interim goodwill test in conjunction with the preparation of our financial statements for the three months ended March 31, 2013.

Impairment testing of goodwill is required at the reporting unit level and involves a two-step process. We identified two reporting units for evaluating goodwill, which were Business Services and Consumer Services. Each of these reporting units constitutes a business for which discrete financial information is available and segment management regularly reviews the operating results. The first step of the impairment test involves comparing the estimated fair values of our reporting units with the reporting units' carrying amounts, including goodwill. We estimated the fair values of our reporting units based on weighting of the income and market approaches. These models use significant unobservable inputs, or Level 3 inputs, as defined by the fair value hierarchy. Under the income approach, the fair value of the reporting unit was estimated based on the present value of estimated cash flows using a discounted cash flow method. The significant assumptions used in the discounted cash flow method included internal forecasts and projections developed by management for planning purposes, available industry/market data, strategic plans, discount rates and the growth rate to calculate the terminal value. Under the market approach, the fair value was estimated using the guideline company method. We selected guideline companies in the industry where each reporting unit operates.

Upon completion of the first step, we determined that the carrying value of our Business Services reporting unit exceeded its estimated fair value, so a second step was performed to compare the carrying amount of goodwill to the implied fair value of that goodwill. The implied fair value of goodwill for the Business Services reporting unit was determined in the same manner as utilized to recognize goodwill in a business combination. To determine the implied value of goodwill, fair values were allocated to the assets and liabilities of the Business Services reporting unit as of March 31, 2013. The implied fair value of goodwill was measured as the excess of the fair value of the Business Services reporting unit over the amounts assigned to its assets and liabilities. The impairment loss of $256.7 million during the three months ended March 31, 2013 was measured as the amount the carrying value of goodwill exceeded the implied fair value of the goodwill. We are still finalizing the second step of our goodwill impairment test. As such, the measurement of the impairment loss is an estimate and may require adjustment in a subsequent reporting period.

Approximately $33.8 million of goodwill attributable to the Business Services reporting unit remains as of March 31, 2013. Deterioration in market conditions or estimated future cash flows in this reporting unit could result in future goodwill impairment. We continue to monitor events and circumstances which may affect the fair value of this reporting unit.

Restructuring, acquisition and integration-related costs

Restructuring, acquisition and integration-related costs consisted of the following during the three months ended March 31, 2012 and 2013:

	Three Months Ended
	March 31,					Change
	2012			2013		Dollars			Percent
	(in thousands)
Severance and retention costs	$	1,547		$	4,727	$	3,180		206%
Integration-related costs	1,151			5,002		3,851			335%
Transaction-related costs	839			104		(735		)	(88)%
Facility-related costs	165			1,568		1,403			850%
Legacy plan restructuring costs	(181		)	—		181			(100)%
Restructuring, acquisition and integration-related costs	$	3,521		$	11,401	$	7,880		224%

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Restructuring, acquisition and integration-related costs consist of costs related to EarthLink’s restructuring, acquisition and integration-related activities. Such costs include: 1) severance and retention costs; 2) integration-related costs, such as system conversion, rebranding costs and integration-related consulting and employee costs; 3) transaction-related costs, which are direct costs incurred to effect a business combination, such as advisory, legal, accounting, valuation and other professional fees; and 4) facility-related costs, such as lease termination and asset impairments. Restructuring, acquisition and integration-related costs are expensed in the period in which the costs are incurred and the services are received and are included in restructuring, acquisition and integration-related costs in the Condensed Consolidated Statements of Comprehensive Income (Loss).

The increase in restructuring, acquisition and integration-related costs compared to the prior year period was primarily due to an increase in integration-related costs such as severance costs incurred to eliminate duplicate positions and gain synergies, costs to exit duplicate facilities, and costs to integrate operating support systems and networks. During the first quarter of 2013, we restructured our sales organization in order to better meet the needs of the IT services market, which resulted in a reduction in our sales workforce and some office closings. We also decided to exit telecom systems sales early in 2013 to enable focus on our hosted VoIP platform for new voice customers, which resulted in a small number of position eliminations.

We expect to incur additional integration costs related to our acquisitions. Once the businesses are fully integrated, we expect to realize cost synergies from the combined businesses. However, we may incur upfront costs to gain these synergies, which may take longer or present greater cost to realize than originally anticipated. Such costs may include severance and employee benefits, the elimination of duplicate facilities and contracts and costs to develop common operating platforms.

Interest expense and other, net

The following table presents our interest expense and other, net, for the three months ended March 31, 2012 and 2013:

	Three Months Ended
	March 31,						Change
	2012			2013			Dollars			Percent
	(dollars in thousands)
Interest expense	$	15,749		$	14,817		$	(932	)	(6)%
Interest income	(72		)	(48		)	24			(33)%
Other, net	81			(213		)	(294		)	(363)%
Total	$	15,758		$	14,556		(1,202		)	(8)%

Interest expense and other, net, is primarily comprised of interest expense incurred on our debt and capital leases, amortization of debt issuance costs, debt premiums, and debt discounts; interest earned on our cash, cash equivalents and marketable securities; and other miscellaneous income and expense items.

The decrease in interest expense and other, net, compared to the prior year period was primarily due to the redemption of $32.5 million aggregate principal amount of our 10.5% senior secured notes due April 1, 2016 (the "ITC^DeltaCom Notes") on December 6, 2012. Partially offsetting this decrease was a decrease in interest income due to lower investment yields and lower cash and marketable securities.

Income tax (provision) benefit

The following table presents the components of the income tax (provision) benefit for the three months ended March 31, 2012 and 2013:

	Three Months Ended
	March 31,
	2012			2013
	(in thousands)
Current provision	$	(1,930	)	$	(129	)
Deferred (provision) benefit	(1,244		)	32,248
Total income tax (provision) benefit	$	(3,174	)	$	32,119

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The current tax provision for the three months ended March 31, 2013 was due to discrete items of prior year state tax expense and penalties and interest related to uncertain tax positions. The non-cash deferred tax benefit was due primarily to net operating loss carryforwards and the impairment of tax deductible goodwill.

We have a valuation allowance of $38.6 million against certain deferred tax assets. Of this amount, approximately $31.6 million relates to net operating losses generated by the tax benefits of stock-based compensation. The valuation allowance will be removed upon utilization of these net operating losses by us as an adjustment to additional paid-in-capital.  Approximately $6.6 million relates to net operating losses in certain jurisdictions where we believe it is not “more likely than not” to be realized in future periods. In addition, a valuation allowance of $0.4 million was established in 2010 relating to stock compensation deferred tax assets.

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

We recognize deferred tax assets and liabilities using tax rates in effect for the years in which temporary differences are expected to reverse, including net operating loss carryforwards. Management assesses the realizability of deferred tax assets and records a valuation allowance if it is more-likely-than-not that all or a portion of the deferred tax assets will not be realized. We consider the probability of future taxable income and our historical profitability, among other factors, in assessing the amount of the valuation allowance. Significant judgment is involved in this determination, including projections of future taxable income. Changes in these estimates and assumptions could materially affect the amount of valuation allowance. Adjustments could be required in the future if we estimate that the amount of deferred tax assets that we are more-likely-than-not able to realize is more or less than the net amount we have recorded. Any change in the valuation allowance could have the effect of increasing and/or decreasing stockholders' equity or the income tax provision in the statement of comprehensive income (loss). 

Segment Results of Operations

We operate two reportable segments, Business Services and Consumer Services. We present our segment information along the same lines that our chief executive reviews our operating results in assessing performance and allocating resources. Our Business Services segment earns revenue by providing a broad range of data, voice and IT services to businesses and communications carriers. Our Consumer Services segment provides nationwide Internet access and related value-added services to residential customers.

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

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Business Services Segment

Business Services Operating Metrics

We utilize certain non-financial and operating measures to assess our financial performance. The following table sets forth operating data as of March 31, 2012 and 2013:

	March 31, 2012	March 31, 2013
Total fiber optic route miles (a)	28,804	29,421
Colocations	1,415	1,483
Voice and data switches	56	61

(a) As of March 31, 2012 and 2013, includes 24,859 and 25,476, respectively, route miles owned or obtained through indefeasible rights to use (IRU) and 3,945 marketed and managed route miles.

Business Services Operating Results

The following table sets forth operating results for our Business Services segment for the three months ended March 31, 2012 and 2013:

	Three Months Ended
	March 31,				Change
	2012		2013		Dollars			Percent
	(dollars in thousands)
Segment revenues	$	260,264	$	247,791	$	(12,473	)	(5	)%
Segment operating income	42,422		32,311		(10,111		)	(24	)%

The decrease in Business Services revenues during the three months ended March 31, 2013 compared to the prior year period was due to a decline in revenues for certain legacy products, including traditional voice, web hosting and lower-end, single site broadband services. The decrease was partially offset by an increase in revenues from our newer products, including IT services and MPLS, and an increase due to the favorable settlement of working capital adjustments associated with the acquisition of One Communications recorded during 2013.

The decrease in Business Services operating income during the three months ended March 31, 2013 was primarily due to the decrease in revenues discussed above and an increase in operating costs for IT services. Partially offsetting these decreases was a decline in operating costs due to cost synergies realized from the integration of acquired businesses and the decline in cost of revenue for certain legacy products.

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Consumer Services Segment

Consumer Services Operating Metrics

The following table sets forth subscriber and operating data for our Consumer Services segment for the three months ended March 31, 2012 and 2013:

	Three Months Ended
	March 31,
	2012			2013
Consumer Subscriber Activity
Subscribers at beginning of period	1,350,000			1,152,000
Gross organic subscriber additions	45,000			31,000
Churn	(100,000)			(76,000)
Subscribers at end of period (a)	1,295,000			1,107,000
Consumer Metrics
Average narrowband subscribers (b)	722,000			614,000
Average broadband subscribers (b)	600,000			514,000
Average consumer subscribers (b)	1,322,000			1,128,000
ARPU (c)	$	21.20		$	21.34
Churn rate (d)	2.5		%	2.2		%

(a) Subscriber counts do not include new 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) Average subscribers 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 period.

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

(d) 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.

Consumer Services Operating Results

The following table sets forth operating results for our Consumer Services segment for the three months ended March 31, 2012 and 2013:

	Three Months Ended
	March 31,				Change
	2012		2013		Dollars			Percent
	(dollars in thousands)
Segment revenues	$	84,112	$	72,225	$	(11,887	)	(14	)%
Segment operating income	40,194		34,796		(5,398		)	(13	)%

The decrease in Consumer Services revenues and operating income compared to the prior year period was primarily due to the continued maturation of and competition in the market for consumer Internet access and competitive pressures in the industry. The decrease in revenue was partially offset by a decrease in operating expenses as our consumer subscriber base has decreased and become longer-tenured. Our longer tenured customers require less customer service and technical support and have a lower frequency of non-payment.

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Liquidity and Capital Resources

The following table sets forth summarized cash flow data for the three months ended March 31, 2012 and 2013:

	Three Months Ended
	March 31,						Change
	2012			2013			Dollars			Percent
	(dollars in thousands)
Net cash provided by operating activities	$	66,211		$	31,844		$	(34,367	)	(52	)%
Net cash used in investing activities	(50,212		)	(42,751		)	7,461			(15	)%
Net cash used in financing activities	(5,779		)	(566		)	5,213			(90	)%
Net increase (decrease) in cash and cash equivalents	$	10,220		$	(11,473	)	$	(21,693	)	(212	)%

Operating activities

The decrease in cash provided by operating activities during the three months ended March 31, 2013 compared to the prior year period was primarily due to the overall decrease in revenues as well as a decrease in working capital related to timing of accounts receivable, prepaid expenses and other assets and accounts payable.

Investing activities

The decrease in net cash used in investing activities during the three months ended March 31, 2013 compared to the prior year period was primarily due to a net decrease in purchases of marketable securities. During the three months ended March 31, 2012, we purchased $19.2 million in marketable securities, compared to net sales and maturities of marketable securities of $0.9 million during the three months ended March 31, 2013. Partially offsetting this decrease was a $10.7 million increase in capital expenditures as we expand our fiber network and upgrade our network and technology infrastructure.

Financing activities

The decrease in net cash used in financing activities during the three months ended March 31, 2013 compared to the prior year period was primarily due to a decrease in dividend payments related to timing of our quarterly dividend payment to shareholders. During the three months ended March 31, 2012 and 2013, cash dividends declared were $0.05 per share. However, our first quarter 2012 dividend payment was paid to shareholders of record within the quarter and our first quarter 2013 dividend payment was paid to shareholders of record subsequent to the quarter in April 2013.

Future Uses of cash

Our primary future cash requirements relate to outstanding indebtedness, capital expenditures, investments in our business services segment, acquisition and integration-related costs and dividends. In addition, we may use cash in the future to make strategic acquisitions or repurchase common stock or debt.

Debt and interest. We expect to use cash to service our outstanding indebtedness, including ITC^DeltaCom's outstanding $292.3 million aggregate principal amount of the ITC^DeltaCom Notes, our $300.0 million aggregate principal amount of Senior Notes in May 2011 and our $150.0 million revolving credit facility. We expect to use cash for interest payments. Additionally, we may use cash to redeem the ITC^DeltaCom Notes in accordance with the terms of the related indenture, to purchase the ITC^DeltaCom Notes in the open market or to refinance with new debt. While we discontinued the refinancing efforts we undertook in the first quarter of 2013 due to market conditions, we continue to evaluate our refinancing alternatives.

Capital expenditures. We expect to incur capital expenditures of approximately $140.0 million to $155.0 million during 2013. The capital expenditures are for expansion of our fiber network, the acquisition of new customers and to maintain and upgrade our network and technology infrastructure. The actual amount of capital expenditures may fluctuate due to a number of factors which are difficult to predict and could change significantly over time. Additionally, technological advances may require us to make capital expenditures to develop or acquire new equipment or technology in order to replace aging or obsolete equipment.

Investments in our Business Services segment. One of our key strategies is to grow our Business Services revenue. We are deploying a wide array of cloud, managed security and IT support services. We expect to invest cash in sales and marketing

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efforts and resources required to support our business services, including investments in search engine marketing campaigns and advertising to increase brand awareness.

Restructuring, acquisition and integration-related costs. We expect to continue to use cash for one-time costs related to our acquisitions, including severance costs and integration-related costs. We are currently integrating our operating support system and certain billing systems, which we expect to be substantially completed in 2013. We expect to incur expenses in connection with completing our integration. In January 2013, we restructured our sales organization in order to better meet the needs of the IT services market and decided to exit telecom systems sales early in 2013 to focus on our hosted VoIP platform for new voice customers. We will continue to evaluate our business, and may incur costs for additional restructuring activities.

Dividends. During the three months ended March 31, 2012 and 2013, cash dividends declared were $0.05 per common share. We currently intend to continue to pay regular quarterly dividends on our common stock. However, any decision to declare future dividends will be made at the discretion of the Board of Directors and will depend on, among other things, our results of operations, financial condition, cash requirements, investment opportunities and other factors the Board of Directors may deem relevant.

Other. We may use cash to invest in or acquire other companies, to repurchase common stock or to repurchase or redeem debt. We expect to continue to evaluate and consider potential strategic transactions that we believe may complement or grow our business. Although we continue to consider and evaluate potential strategic transactions, there can be no assurance that we will be able to consummate any such transaction.

Our cash requirements depend on numerous factors, including costs required to integrate our acquisitions, costs incurred to redeem or repurchase debt, the size and types of future acquisitions in which we may engage, the costs required to maintain our network infrastructure, the outcome of various telecommunications-related disputes and proceedings, the pricing of our services and the level of resources used for our sales and marketing activities, among others. In addition, our use of cash in connection with acquisitions may limit other potential uses of our cash, including stock repurchases, debt repayments or repurchases and dividend payments.

Future sources of cash

Our principal sources of liquidity are our cash, cash equivalents and marketable securities, as well as the cash flow we generate from our operations. During the three months ended March 31, 2012 and 2013, we generated $66.2 million and $31.8 million in cash from operations, respectively. As of March 31, 2013, we had $146.1 million in cash and cash equivalents and $46.0 million in marketable securities. Our cash, cash equivalents and marketable securities are subject to general credit, liquidity, market, and interest rate risks, which may be exacerbated by unfavorable economic conditions.

Another source of liquidity is our revolving credit facility. We have a credit agreement providing for a senior secured revolving credit facility with aggregate revolving commitments of $150.0 million. The senior secured revolving credit facility terminates in May 2015, and at that time any amounts outstanding thereunder shall be due and payable in full. As of March 31, 2013, no amounts had been drawn or were outstanding under the senior secured revolving credit facility.

Our available cash and cash equivalents, together with our results of operations, are expected to be sufficient to meet our operating expenses, service outstanding indebtedness, capital requirements and investment and other obligations for at least the next 12 months. However, to refinance existing indebtedness, to increase available liquidity or to fund acquisitions or other strategic activities, we may seek additional financing. We have no commitments for any additional financing and have no lines of credit or similar sources of financing, other than the $150.0 million credit facility. We cannot be sure that we can obtain additional financing on favorable terms, if at all, through the issuance of equity securities or the incurrence of additional debt. Additional equity financing may dilute our stockholders, and debt financing, if available, may restrict our ability to repurchase common stock or debt, declare and pay dividends and raise future capital. If we are unable to obtain additional needed financing, it may prohibit us from refinancing existing indebtedness and making acquisitions, capital expenditures and/or investments, which could materially and adversely affect our business.

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Debt Covenants

Under the indentures governing our debt agreements, acceleration on principal payments would occur upon payment default or violation of debt covenants. We were in compliance with all covenants under our debt agreements as of March 31, 2013. As a result of an increase in capital expenditures, we may not satisfy the minimum consolidated interest coverage ratio set forth in our revolving credit facility in the future. Based on discussion with the administrative agent for the Credit Agreement, we believe we would be able to amend the Credit Agreement to permit compliance with this covenant. However, if we breached this covenant, we would not be able to access funds under the revolving credit facility. This would not impact our results of operations as no amounts are drawn under the credit facility. However, it would provide us with less flexibility for strategic transactions and other potential business needs.

Off-Balance Sheet Arrangements

As of March 31, 2013, we did not have any off-balance sheet arrangements that have or are reasonably likely to have a current or future effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources that are material to investors.

Share Repurchase Program

The Board of Directors has authorized a total of $750.0 million to repurchase our common stock under our share repurchase program. As of March 31, 2013, we had utilized approximately $676.5 million pursuant to the authorizations and had $73.5 million available under the current authorization. We may repurchase our common stock from time to time in compliance with the Securities and Exchange Commission’s regulations and other legal requirements, and subject to market conditions and other factors. The share repurchase program does not require us to acquire any specific number of shares and may be terminated by the Board of Directors at any time.

Non-GAAP Financial Measures

In addition to our financial information presented in accordance with U.S. generally accepted accounting principles (“GAAP”), management uses certain “non-GAAP financial measures” within the meaning of the SEC Regulation G, to clarify and enhance understanding of past performance and prospects for the future. Generally, a non-GAAP financial measure is a numerical measure of a company’s operating performance, financial position or cash flows that excludes or includes amounts that are included in or excluded from the most directly comparable measure calculated and presented in accordance with GAAP. Set forth below is a discussion of the presentation and use of Adjusted EBITDA and Unlevered Free Cash Flow, the non-GAAP financial measures used by management.

Adjusted EBITDA is defined as net income (loss) before interest expense and other, net, income tax provision (benefit), depreciation and amortization, stock-based compensation, impairment of goodwill and intangible assets, and restructuring, acquisition and integration-related costs.  Unlevered Free Cash Flow is defined as net income before interest expense and other, net, income tax provision (benefit), depreciation and amortization, stock-based compensation, impairment of goodwill and intangible assets, and restructuring, acquisition and integration-related costs, less cash used for purchases of property and equipment.

These non-GAAP financial measures are commonly used in the industry and are presented because management believes they provide relevant and useful information to investors. Management uses these non-GAAP financial measures to evaluate the performance of its business. Management also uses Unlevered Free Cash Flow to assess its ability to fund capital expenditures, fund growth and service debt. Management believes that excluding the effects of certain non-cash and non-operating items enables investors to better understand and analyze the current period’s results and provides a better measure of comparability.

There are limitations to using these non-GAAP financial measures. Adjusted EBITDA and Unlevered Free Cash Flow are not indicative of cash provided or used by operating activities and may differ from comparable information provided by other companies.  Adjusted EBITDA and Unlevered Free Cash Flow should not be considered in isolation, as an alternative to, or more meaningful than measures of financial performance determined in accordance with U.S. GAAP.

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The following table presents a reconciliation of Adjusted EBITDA to the most closely related financial measure reported under GAAP for the three months ended March 31, 2012 and 2013:

	Three Months Ended
	March 31,
	2012		2013
	(in thousands)
Net income (loss)	$	7,263	$	(236,415	)
Interest expense and other, net	15,758		14,556
Income tax provision (benefit)	3,174		(32,119		)
Depreciation and amortization	45,254		43,400
Impairment of goodwill	—		256,700
Stock-based compensation expense	2,672		3,969
Restructuring, acquisition and integration-related costs	3,521		11,401
Adjusted EBITDA	$	77,642	$	61,492

The following table presents a reconciliation of Unlevered Free Cash Flow to the most closely related financial measure reported under GAAP for the three months ended March 31, 2012 and 2013:

	Three Months Ended
	March 31,
	2012			2013
	(in thousands)
Net income (loss)	$	7,263		$	(236,415	)
Interest expense and other, net	15,758			14,556
Income tax provision (benefit)	3,174			(32,119		)
Depreciation and amortization	45,254			43,400
Impairment of goodwill	—			256,700
Stock-based compensation expense	2,672			3,969
Restructuring, acquisition and integration-related costs	3,521			11,401
Purchases of property and equipment	(31,775		)	(42,454		)
Unlevered Free Cash Flow	$	45,867		$	19,038

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The following table presents a reconciliation of Unlevered Free Cash Flow, as a liquidity measure, to net cash provided by operating activities for the three months ended March 31, 2012 and 2013:

	Three Months Ended
	March 31,
	2012			2013
	(in thousands)
Net cash provided by operating activities	$	66,211		$	31,844
Income tax provision (benefit)	3,174			(32,119		)
Non-cash income taxes	(1,244		)	32,248
Interest expense and other, net	15,758			14,556
Amortization of debt discount, premium and issuance costs	494			414
Restructuring, acquisition and integration-related costs	3,521			11,401
Changes in operating assets and liabilities	(9,989		)	2,763
Purchases of property and equipment	(31,775		)	(42,454		)
Other, net	(283		)	385
Unlevered Free Cash Flow	$	45,867		$	19,038
Net cash used in investing activities	$	(50,212	)	$	(42,751	)
Net cash used in financing activities	$	(5,779	)	$	(566	)

Cautionary Note Concerning Factors That May Affect Future Results

The Management’s Discussion and Analysis and other portions of this Quarterly Report on Form 10-Q include “forward-looking” statements (rather than historical facts) that are subject to risks and uncertainties that could cause actual results to differ materially from those described. Although we believe that the expectations expressed in these forward-looking statements are reasonable, we cannot promise that our expectations will turn out to be correct. Our actual results could be materially different from and worse than our expectations. With respect to such forward-looking statements, we seek the protections afforded by the Private Securities Litigation Reform Act of 1995. These risks and uncertainties (1) that we may not be able to execute our strategy to be an IT services company for small and medium-sized businesses with IT and network security needs, which could adversely affect our results of operations and cash flows; (2) that we may not be able to grow revenues from our evolving Business Services product portfolio to offset declining revenues from our legacy Business Services products and from our Consumer Services segment, which could adversely affect our results of operations and cash flows; (3) that we may not be able to develop the optimal sales model necessary to implement our business strategy; (4) that we may be unsuccessful integrating acquisitions into our business, which could result in operating difficulties, losses and other adverse consequences; (5) that if we are unable to adapt to changes in technology and customer demands, we may not remain competitive, and our revenues and operating results could suffer; (6) that our failure to achieve operating efficiencies will adversely affect our results of operations; (7) that as a result of our continuing review of our business, we may have to undertake further restructuring plans that would require additional charges, including incurring facility exit and restructuring charges; (8) that unfavorable general economic conditions could harm our business; (9) that we may be unable to successfully identify, manage and assimilate future acquisitions, which could adversely affect our results of operations; (10) that we face significant competition in the IT services and communications industry that could reduce our profitability; (11) that decisions by legislative or regulatory authorities, including the Federal Communications Commission relieving incumbent carriers of certain regulatory requirements, and possible further deregulation in the future, may restrict our ability to provide services and may increase the costs we incur to provide these services; (12) that if we are unable to interconnect with AT&T, Verizon and other incumbent carriers on acceptable terms, our ability to offer competitively priced local telephone services will be adversely affected; (13) that our operating performance will suffer if we are not offered competitive rates for the access services we need to provide our long distance services; (14) that we may experience reductions in switched access and reciprocal compensation revenue; (15) that failure to obtain and maintain necessary permits and rights-of-way could interfere with our network infrastructure and operations; (16) that we have substantial business relationships with several large telecommunications carriers, and some of our customer agreements may not continue due to financial difficulty, acquisitions, non-renewal or other factors, which could adversely affect our wholesale revenue and results of operations; (17) that we obtain a majority of our network equipment and software from a limited number of third-party suppliers; (18) that work stoppages experienced by other communications companies on whom we rely for service could adversely impact our ability to provision and service our customers; (19) that our commercial and alliance arrangements may not be renewed or may not generate expected

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benefits, which could adversely affect our results of operations; (20) that our consumer business is dependent on the availability of third-party network service providers; (21) that we face significant competition in the Internet access industry that could reduce our profitability; (22) that the continued decline of our consumer access subscribers, combined with the change in mix of our consumer access base from narrowband to broadband, will adversely affect our results of operations; (23) that potential regulation of Internet service providers could adversely affect our operations; (24) that if we, or other industry participants, are unable to successfully defend against disputes or legal actions, we could face substantial liabilities or suffer harm to our financial and operational prospects; (25) that we may be accused of infringing upon the intellectual property rights of third parties, which is costly to defend and could limit our ability to use certain technologies in the future; (26) that we may not be able to protect our intellectual property; (27) that we may be unable to hire and retain sufficient qualified personnel, and the loss of any of our key executive officers could adversely affect us; (28) that our business depends on effective business support systems and processes; (29) that privacy concerns relating to our business could damage our reputation and deter current and potential users from using our services; (30) that cyber security breaches could harm our business; (31) that interruption or failure of our network and information systems and other technologies could impair our ability to provide our services, which could damage our reputation and harm our operating results; (32) that government regulations could adversely affect our business or force us to change our business practices; (33) that regulatory audits have in the past, and could in the future, result in increased costs; (34) that our business may suffer if third parties are unable to provide services or terminate their relationships with us; (35) that we may be required to recognize impairment charges on our goodwill and intangible assets, which would adversely affect our results of operations and financial position; (36) that we may have exposure to greater than anticipated tax liabilities and the use of our net operating losses and certain other tax attributes could be limited in the future; (37) that our indebtedness could adversely affect our financial health and limit our ability to react to changes in our industry; (38) that we may require substantial capital to support business growth or refinance existing indebtedness, and this capital may not be available to us on acceptable terms, or at all; (39) that our debt agreements include restrictive covenants, and failure to comply with these covenants could trigger acceleration of payment of outstanding indebtedness or inability to borrow funds under our existing credit facility; (40) that we may reduce, or cease payment of, quarterly cash dividends; (41) that our stock price may be volatile; and (42) that provisions of our third restated certificate of incorporation, amended and restated bylaws and other elements of our capital structure could limit our share price and delay a change of control of the company  These risks and uncertainties, as well as other risks and uncertainties that could cause our actual results to differ significantly from management’s expectations, are not intended to represent a complete list of all risks and uncertainties inherent in our business, and should be read in conjunction with the more detailed cautionary statements and risk factors included in our Annual Report on Form 10-K for the year ended December 31, 2012.

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Item 3.   Quantitative and Qualitative Disclosures About Market Risk.

There have been no material changes in market risk from the information provided in Part II, Item 7A “Quantitative and Qualitative Disclosures About Market Risk” in our Annual Report on Form 10-K for the year ended December 31, 2012.

Item 4. Controls and Procedures.

Evaluation of Disclosure Controls and Procedures

Pursuant to Rule 13a-15(b) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), we carried out an evaluation, with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of our disclosure controls and procedures (as defined under Rule 13a-15(e) under the Exchange Act) as of the end of the period covered by this report.  Based upon that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures are effective to ensure that information required to be disclosed in the reports that are filed or submitted under the Exchange Act, is recorded, processed, summarized and reported, within the time periods specified in the Securities and Exchange Commission’s rules and forms, and that such information is accumulated and communicated to management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure.

Changes in Internal Control over Financial Reporting

There were no changes in our internal control over financial reporting during the three months ended March 31, 2013 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

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Part II

Item 1. Legal Proceedings.

The Company is party to various legal and regulatory proceedings and other disputes arising from normal business activities. The Company’s management believes that there are no disputes, litigation or other legal or regulatory proceedings asserted or pending against the Company that could have, individually or in the aggregate, a material adverse effect on its financial position, results of operations or cash flows, and believes that adequate provision for any probable and estimable losses has been made in the Company’s condensed consolidated financial statements. However, the result of any current or future disputes, litigation or other legal or regulatory proceedings is inherently unpredictable and could result in liabilities that are higher than currently predicted.

Item 1A.  Risk Factors.

There were no material updates to the risk factors discussed in EarthLink’s Annual Report on Form 10-K for the year ended December 31, 2012.

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

None.

Item 5.  Other Information.

None.

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Item 6.   Exhibits.

(a)Exhibits.   The following exhibits are filed as part of this report:

10.1	2013 Short-Term Incentive Bonus Plan
31.1	Certification of Chief Executive Officer pursuant to Securities Exchange Act Rules 13a-14 and 15d-14, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
31.2	Certification of Chief Financial Officer pursuant to Securities Exchange Act Rules 13a-14 and 15d-14, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
32.1	Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
32.2	Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
101.INS	XBRL Instance Document*
101.SCH	XBRL Taxonomy Extension Schema Document*
101.CAL	XBRL Taxonomy Extension Calculation Linkbase Document*
101.DEF	XBRL Taxonomy Extension Definition Linkbase Document*
101.LAB	XBRL Taxonomy Extension Label Linkbase Document*
101.PRE	XBRL Taxonomy Extension Presentation Linkbase Document*

* Pursuant to Rule 406T of Regulation S-T that this interactive data file is deemed not filed or part of a registration statement or prospectus for the purposes of section 11 or 12 of the Securities Act of 1933, as amended, is deemed not filed for purposes of section 18 of the Securities and Exchanges Act of 1934, as amended, and otherwise is not subject to liability under these sections.

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

		EARTHLINK, INC.
Date:	May 7, 2013	/s/ ROLLA P. HUFF
		Rolla P. Huff, Chairman of the Board and Chief Executive Officer and President (principal executive officer)
Date:	May 7, 2013	/s/ BRADLEY A. FERGUSON
		Bradley A. Ferguson, Chief Financial Officer
		(principal financial and accounting officer)

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