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EarthLink, Inc. (NASDAQ:ELNK)

Q4 2008 Earnings Call.

February 05, 2009, 08:30 AM ET

Executives

Kevin Dotts - CFO

Rolla Huff - Chairman and CEO

Analysts

Youssef Squali - Jefferies & Company

Jennifer Watson - Goldman Sachs

Michael Crawford - Raytheon

Scott Kessler - Standard & Poor's

Presentation

Operator

Good morning everyone and welcome to EarthLink's Fourth Quarter and Year End '08 Earnings Call. Today's call is being recorded. At this time I would like to turn the conference over to Mr. Kevin Dotts Chief Financial Officer for opening remarks and introductions. Please go ahead, sir.

Kevin Dotts

Thanks and welcome everyone to our call. This morning I'm joined by EarthLink's Chairman and CEO Rolla Huff and our Vice President of Corporation Communications Michelle Sadwick and our Vice President of Investor Relations [Lewis Alterman] to discuss our fourth quarter and year end results. Following our comments there will be an opportunity for questions.

Before we continue I would like to point out that certain statements contained in our earnings release and on this conference call are forward-looking statements rather than historical facts that are subject to risk and uncertainties that could cause actual results to differ materially from those described. With respect to such forward-looking statements the company seeks the protection supported by the Private Securities Litigation Reform Act of 1995.

These risks include a variety of factors including competitive developments and risk factors listed in the company's SEC reports and public releases. Those lists are intended to identify certain principle factors that could cause actual results to differ materially from those described in the forward-looking statements but are not intended to represent a complete list of all risks and uncertainties inherent to the company's business.

In an effort to provide useful information to our investors our comments today also include non-GAAP financial measures. For details on these measures including why we use them and reconciliations to the most comparable GAAP measures please refer to our earnings release and the Form 8-K that has been furnished with the SEC both of which are available on our website at www.earthlink.net.

Now, I would like to turn things over to, Rolla.

Rolla Huff

Thanks, Kevin and good morning everyone. Well I hope you agree that the fourth quarter and full year 2008 results we announced today demonstrate that we are continuing to execute on the strategy we announced in August of 2007.

Today we reported $309 million in adjusted EBITDA and $302 million in free cash flow for full year 2008, up 66% and a 141% respectively over 2007.

While we continue to keep a close eye on the deepening economic crisis we feel comfortable reaffirming our prior adjusted EBITDA guidance for 2009 and raising our 2009 free cash flow guidance, and Kevin will take you through that a little bit later.

For the fourth quarter average monthly subscriber churn across all products was 3.9% down from 4.2% in the third quarter of 2008 and down from 5.2% we recorded at year end 2007.

We've been closely monitoring any impact that current economic environment might have on our business, its still too early to come to any real conclusions but let me spend a few minutes on what we are seeing.

At a high level, there is an argument to be made during these tough economic times financially constrained consumers might give up the luxury of the triple play or high data speeds and instead migrate to the lowest price point alternative that allows them to retain basic Internet access. We are seeing some increase in call volumes and growth subscriber additions on our EarthLink branded dial up product.

One competitor of ours actually is making a meaningful national advertising push around the message that dial up access can save consumers billions of dollars which it can by the way.

Average monthly churn for premium dial improved to 3.2% a 50 basis point improvement over the third quarter and a 110 basis point improvement over the prior year quarter. Probably more notable is that we saw our Q4 average monthly churn come down from the third quarter and the prior year fourth quarter in seven of the eight tenure cohorts we track.

The strength of EarthLink brand combined with the save money message that is being continuously broadcast nationwide, could be providing some positive momentum for us in premium dial. Obviously we hope this becomes a trend, but truly I think it's too early to tell.

Unlike our premium dial business, we saw an increase in average monthly churn across most tenure cohorts in our value oriented PeoplePC product towards the end of the fourth quarter and that's continued into January.

I should note that most of these customers were generally credit challenged which may have contributed to an up tick in customers disconnected for non-payment. This increase in value dial churn in most tenure cohort was offset by the continued aging of overall value dial base.

So, in total PeoplePC average monthly churn remained flat quarter-over-quarter at 6.5%, and it actually improved from the 8.3% we reported in the fourth quarter of '07. We continue to see our lower priced value dial service account for a disproportionately large part of our churn.

These subs represented 55% or over half of our overall subscriber decline and now represent 27% of our consumer access subscriber base. But I think more importantly just 16% of our consumer access revenue base.

Total average monthly broadband churn in the quarter was 2.6%, a 20 basis point improvement over both third quarter of 2008 and the fourth quarter of 2007.

Our proportional mix of tenured customers continues to increase. At the end of the fourth quarter 86% of our premium dial customers had been with us for two years or more. 72% of our DSL broadband base had been with us for over 24 months and 53% of our value dial base had been with us for over 24 months.

We do not see anything in January that would lead us to believe the trends towards an increasing maturity of our base will change in 2009. Interesting to note, broadband now represents 54% of our overall revenue up from 52% in the prior quarter and 49% at the year end 2007.

Now while we know that tenured broadband customers have lower churn rates than tenured dial up customers, we also understand they have lower EBITDA margins. Unlike many of our competitors, when our dial up customers needs warranted, we are able to make an offer to seamlessly upgrade them to our broadband product which reaches over 90% of US households.

This ability has saved upgrade customers is the key differentiator that also contributes to our outlook on the tail on this business.

Revenue churn attenuation combined with further operational optimization resulted in adjusted EBITDA per average sub increasing throughout the year to over $8 a sub by the end of the fourth quarter compared to less than $6 per sub at the end of the prior year fourth quarter.

Our guidance for 2009 reflects our intension to hold adjusted EBITDA margins relatively flat at current levels, even as we continue the evolution of our revenue stream from being primarily narrowband to a revenue stream that is primarily broadband.

We were pleased with our ability to monetize customers through our value added services or VAS business and see this as a key to increasing customer loyalty and retention in addition to contributing to overall profitability.

VAS service includes graphical advertising, search and web security products. VAS ARPU was $2.90 per average sub in the fourth quarter up $0.5 over the prior quarter and $0.22 higher than the fourth quarter of 2007. The increase was driven by significant improvements in subscription revenue which more than offset the slight decline in search and advertising revenue and subscription revenue by the way is primarily security type products.

With more subscribers using ancillary subscription products we saw subscription ARPU increase $0.04 over the third quarter of 2008 and $0.31 or 20% over year end 2007 levels.

Advertising revenue per sub was up slightly over the prior quarter in part due to seasonality offsetting the trend in lower CPMs we have been experiencing in the first three quarters of the year.

A reflection of the general weakness in the advertising market and industry wide declines in CPMs. Search revenue per sub was down slightly as well with volume remaining steady but the result of the decline in RPMs driven by an overall shift in the mix of the types of search is executed.

With the benefit of increased tenure and again continuing process improvement, our average combined customer support and technical support contact rate continue to reach record lows.

Contact rates on per sub basis were down 11% in the quarter and have been reduced by 34% since the prior year fourth quarter driven by a nearly 40% decline in narrowband customer contact rates.

We feel pretty good about that.

Our average customer support cost per sub was $1.32 in the fourth quarter of 2008, down 18% from $1.60 in the prior quarter and 23% improvement over the $1.72 cost per sub we reported at the end of fourth quarter 2007.

All of this has been achieved while maintaining high levels of customer satisfaction in overall network availability.

Customer satisfaction and overall network availability. Customer satisfaction with EarthLink products remain solid as evidenced by our winning the J.D. Power’s award for the dial-up service for the fourth year in a row and we were notified about that in the fourth quarter.

Joe Wetzel, John Bowden and the whole customer service team have had a pretty remarkable year. We actually think there is more room for improvement this year.

Just as importantly our overall network availability held steady at 99.8%. During the fourth quarter, we completed a network consolidation project that optimized our backbone infrastructure.

Also during the quarter, we secured favorable supply and pricing arrangements on broadband access rates through 2010 and our developing strategies to further increase our flexibility in working with our access vendors.

For the past year and half, our people have been incentive to focus on doing the things necessary to maximize customer retention while simultaneously optimizing our cost structure.

We are well aware that the long term value of this company will only be fully realized, if we continue to stay diligent and looking for ways to run this business more efficiently through process improvement, infrastructure rescaling and creative customer acquisition and royalty programs.

Absent needed industry consolidation, we know we must be proactive in building a smaller business, not simply becoming one, and I believe there is an important difference between those two outcomes from a shareholder and an employee perspective.

While its probably not meaningful to most of the folks on this call I have to say I feel so fortunate that the majority of our employee impacts occurred in the third quarter and fourth quarter of 2007. When our people were able to benefit from our solid severance program then quickly move on to their next career opportunity.

I think our quick move to a restructuring decision and our ability to be in the financial position to be fair with everyone impacted and generous with those that have been asked to stay and optimize the future value of this business.

There has been a key ingredient in the success we have had so far. We know there is still a lot of work to do in our continuing process of simultaneously creating a smaller consumer access business while we look for opportunities to increase shareholder value by building a business that can grow in the future. Our people are vital to our future success on both of those counts.

Before I turn the call over to Kevin, I wanted to briefly touch on our SMB small business area which is primarily comprised of our New Edge subsidiary. In the fourth quarter, our SMB business had approximately $1 million in adjusted EBITDA but was slightly free cash flow negative.

Full year 2008, our SMB business was EBITDA positive and slightly free cash flow positive. This represents significant progress from mid 2007 when that business was EBITDA and free cash flow negative.

Over the course of the past year and half New Edge and our business services division has undergone major restructuring and process improvements. Customer service has been reengineered, new products have been launched, our network has been restructured and cost efficiency have been built into the foundation of the operating processes.

Having said that, we know that we need to get much better in all of those areas in 2009. Top line revenue growth in this business segment continues to be a challenge particularly in closing larger enterprise deals. We are seeing real interest in our award winning MPLS over DSL products which allows small business customers to reduce their telecom cost by replacing key one circuits with MPLS over DSL.

However, given the current economic environment customers are increasingly taking a wait and see approach before they finalize commitments.

New Edge has customers that range from small to mid size businesses up to very large multi-site customers with some historical focus in the retail sector and clearly, the retailers have been hit hard by the tightening economy. This was substantial contributor to our seeing new edge average monthly churn in the fourth quarter creep up 29 basis points versus the third quarter.

While we have seen at these factors, we begun the new year, we believe we will continue to feel pressure from the economic downturn that we are in.

New Edge did release two products in the fourth quarter that I think were significant. Those releases included EBDO which provides business class wireless broadband connectivity over a private MPLS based nationwide network which allows us to get to more customers and remote areas.

We also just launched our voice connect product which provides an integrated Voice-over-IP service over a New Edge private network environment.

While we are seeing our new product releases positively impact ARPU we expect the pressure on revenue and churn to continue given the state of the economy. Our objective will continue to be to manage this business to a cash neutral position.

I believe New Edge has a real advantage in their ability to offer cutting edge products nationwide to small business customers. While this economic environment will be difficult on all players in the SMB market this is a potential growth business when the economy begins to improve.

So, now let's turn the call back over to Kevin who will take you through the details of our financial performance in the quarter and full year as well as our updated guidance for 2009. Kevin?

Kevin Dotts

Thanks Rolla. Our fourth quarter and total year results demonstrate the successful execution of our strategy launched in mid 2007.

Our goal in 2009 will continue to be to maximize the cash generated in our consumer access business by keeping our EBITDA margins consistent while we seek strategic opportunities to increase long term shareholder value.

Our overall revenue for the quarter was $2.16 million a 23% decrease on the fourth quarter of last year and $15 million decrease from last quarter primarily driven by declines in narrowband subscribers.

This was expected given our revised focus surrounding customer acquisition. As we entered 2008, revenue was declining on an average over $18 million to $19 million per quarter consistent with our expectations revenue is now declining at approximately $15 million per quarter.

As the company continues to experience subscriber churn by cohort at historical rates. We expect to realize further revenue contraction. Although, we have seen a slight increase in churn rates amongst certain value narrowband and DSL tenure segments we expect the revenue decline to continue to attenuate in 2009.

In addition, to our churn performance as Rolla, previously mentioned our value added services revenue per subscriber continued to approve to $2.90 per engaged user as we are better able to monetize incremental subscription revenues due to our relationship with our customers.

This is particularly noteworthy given today's general industry trends in the search, advertising and online advertising markets. We continue to manage both the variable and fixed cost structure to maximize our margins in cash generation. However, as variable costs become a lower percentage of our total cost structure, we do not expect to experience the same level of declines going forward.

Our cost of revenues declined by approximately $5 million leaving a gross margin decline of approximately $10 million in the fourth quarter compared to the third quarter of 2008.

While we were able to manage the same relative gross margin rate compared to the third quarter of 2008 as the proportion of our broadband revenues increase, broadband having lower gross margin rates when compared to narrowband.

We expect that total gross margin rate to modestly decline in 2009. And while the change in mix will cause total gross margin rates to decline, I would note that broadband has lower churn characteristics resulting in cash flow or a life time value that can be equivalent of narrowband subscribers if not better than certain narrowband subscribers.

As Rolla, pointed out, we are working hard to build a smaller but more profitable business and have achieved cost optimization and efficiencies in all areas of the company.

Total operating expenses including customer support expenses, operations expenses and general and administrative expenses were $52 million for the quarter and $231 million for the full year 2008. Down 30% from the fourth quarter of 2007 and down 34% from the full year of 2007.

Sales and marketing costs were $19 million in the fourth quarter and $98 million for the full year of 2008, down $25 million from the fourth quarter of 2007 and $193 million less than we spent in 2007.

As revenue contracted, we were able to increase the productivity of our operating margin as defined by total company revenue less cost of revenue sales and marketing and other operating cost mentioned previously. 29% for the fourth quarter and improving from 28% in the third quarter and 21% in the fourth quarter of 2007. I think that is particularly notable given we would naturally expect to see scaling opportunities reduce as subscribers and revenues decline.

Along with a more tenured customer base we have experienced a reduction in the number of the refunds, credits and chargeback. In addition, bad debt and payment processing cost were down more than 8% over the prior quarter and down almost 38% versus year ago levels.

For the fourth quarter of 2008, despite a decline of $44 million of gross margin compared to the fourth quarter of 2007 we generated adjusted EBITDA of $72 million, a $1 million improvement over the fourth quarter of 2007.

Due to our continued focus on support and other operating cost reductions reduced bad debt payment processing expenses and reduced sales and marketing expenses.

EarthLink's income from continuing operations during the quarter was $27 million or $0.25 per share compared to $23 million or $0.19 per share in the prior year fourth quarter for an improvement of $4 million.

During the fourth quarter of 2008 we recorded a $79 million non-cash impairment charge of goodwill and solid intangible assets related New Edge networks.

We also recorded $3 million of other than temporary impairments due to a decline in the value of our Virgin Mobile investment. Offsetting these changes, charges was a $26 million decrease in facility exit and restructuring cost compared to the fourth quarter of 2007 and a $56 million increase in an income tax benefit recorded in the fourth quarter of 2008 due to the partial release of evaluation allowance against our net operating loss tax carry forwards.

I would like to highlight that while we expect to record a quarterly higher non-cash tax expense in 2009, in future we also expect to continue to recognize the benefit of over a $190 million tax affected that federal and state net operating loss tax carry forwards.

In 2009 we expect to continue to remain a federal and state income cash tax rate of approximately 3% to 4%. For the fourth quarter of 2008, EarthLink generated net income of $27 million or $0.25 per share compared to a net loss of $9 million or negative $0.8 per share in the fourth quarter of 2007.

In the fourth quarter of 2007 EarthLink recorded $32 million or a negative $0.27 per share loss from discontinued operations. Again we generated $72 million of adjusted EBITDA in the fourth quarter of 2008.

We used $2 million for capital expenditures and cash payments for subscriber base additions in the quarter compared to $12 million in the fourth quarter of 2007 which resulted in $70 million of free cash flow during the fourth quarter of 2008 up from the $59 million generated in the fourth quarter of last year.

During the full year of 2008, we generated $309 million adjusted EBITDA and increase of $123 million from 2007. We used $7 million of capital expenditures and cash payments per subscriber acquisitions resulting in $302 million of free cash flow.

We recovered $57 million from our [Cobad] investment which was offset by repurchases of over $30 million of our own equity and $73 million of lower working capital, restructuring cash payments, cash tax payments and other charges.

Additionally, we reclassified $10 million of cash and marketable securities into a put right asset which is related to our fourth quarter agreement to sell $58 million of par value auction rate securities to UBS on June 30, 2010.

We ended 2008 with $534 million of cash and marketable securities, up $246 million from our $289 million balance at the end of 2007.

We will now provide our outlook for 2009. Throughout 2008 EarthLink realized financial results that were above our initial expectations much as this is driven by the fact that as we enter 2008 we had limited experience on what to expect from our customers and from our people and had significantly simplified access business focused on maximizing cash flow.

Now with over year's worth of experience we do want to reflect on the better performance of subscriber additions and certain sales channels.

The churn performance of our tenured customers, the cost benefits of a significantly tenured customer base and our ability to reduce variable fixed costs.

Today we remain in a very challenging economic environment and while some of the tenured segments in our consumer access business have demonstrated some very modest churn increases, our largest cash providing customer base, our premium narrowband product churn by tenure segment has only improved throughout 2008.

As we look forward to 2009, our goal is to manage the business to an adjusted EBITDA margin rate consistent with 2008 results.

As we discussed in our last call, we are reconfirming our earlier preliminary 2009 guidance that we expect to record $210 million to $225 million in adjusted EBITDA. As we now expect to spend $10 million to $20 million on capital expenditures, this adjusted EBITDA should translate into a $190 million to $215 million of free cash flow.

We expect to record a materially higher tax rate of approximately 38% to 42% for 2009 or approximately $70 million to $75 million of taxes resulting in income from continuing operations of $75 million to $95 million. Actual cash taxes will be $5 million to $9 million related to federal and state corporate AMT. Taxes paid will extend our tax assets going forward.

I would now like to turn the call back to Rolla for some concluding remarks.

Rolla Huff

Thanks Kevin. On the last call, I told you, that I would be giving you an update on how we are thinking about the various alternatives we have around capital structure and potential uses of cash. It's a question that clearly has been a topic of discussion at every board meeting this year.

First, I think its worth repeating a particular point actually that Kevin made a few minutes ago and I believe a theme that you heard throughout this call. As Kevin pointed out, we ended the year with $534 million in cash and marketable securities.

Even as over the course of the year we repurchased over $30 million of our stock, we decreased our cash liabilities by over $70 million and wrote down our ARS balance of $10 million even though we are going to get the money back next year.

We worked every aspect of our cost structure and sold or exited cash trading activities that would not generate long-term shareholder value.

We have a very high hurdle in this company around what we use our cash for. Put it another way, I don't think we have demonstrated any tendency to be fast and loose with our cash. I hope you will agree that our ability to have discipline in how we execute on our business and the discipline that we have demonstrated around decisions we have made on the strategic alternatives that began coming our way in 2008 served our shareholders pretty well in 2008.

Over the first half of last year we outlined the merits of dial up industry consolidation and why we believed we were logical consolidator.

Our view was and actually continues to be that this industry needs to be consolidated and the substantial shareholder value could be created for industry shareholders. However, as time has elapsed, its clear that we were much more focused on this strategy than others in the industry.

I think it's a pity because as we all know, you can not recover the value of lost operating synergies ever.

During the third quarter we begin to more aggressively consider strategic investment alternatives in businesses that we are currently in, beyond just narrowband access. As evidenced by our not announcing any transactions, we found no deals that were compelling in terms of shareholder value creation.

And I was very open with you about the growing attractiveness of various alternatives to return cash to our shareholders. As we all know as the third quarter was ending, we were all becoming increasingly aware of the growing weaknesses in the credit markets.

Well, over the course of November, December and January the debt in equity markets experienced a historic deterioration and as we said here, there is no real clarity around how much worse it will get or how long it will last.

Credit markets have closed all but the strongest companies, equity evaluation have bit plummeted and the slow down in the purchasing power of our economy is affecting companies big and small.

Companies that only a few short months ago, we are seen as industry high flyer with attractive business models are now in danger of violating covenants or not being able to refinance approaching debt maturities.

This environment has created real short to mid term risk for many companies. The combination of caution and execution that we demonstrated to date has created the possibility for us to leverage all this dislocation to our shareholders' advantage.

We have meaningful strength in our balance sheet. Our strong future cash generation capabilities over the next few years is pretty clear and our public currency that is gotten substantially stronger relative to other companies in the technology industry is also clear. I don't see a strategic transaction or a program to return cash as being necessarily mutually exclusive. Nothing is off the table in my mind.

I heard from many of our largest shareholders. And I have to say with very few exceptions the feedback has been to hold on to our cash and stay patient for a while longer until the ability to leverage our financial strength into this developing crisis is better understood, I believe that's the right answer.

To be clear with you I did not take their shareholder feedback as a view that they were encouraging me to go out and start buying stuff.

As a meaningful shareholder that bought shares when I arrived and as the guide who would have to deliver the value of any transaction. I am sensitive to taking on integration risk in this difficult environment. But I also recognize that it is precisely in this kind of environment that real value emerges for those strong enough to take advantage of it.

I am also aware of the technology and churn risk that has put an incredibly low terminal value on our business.

I am convinced to keeping all of the options on the table a bit longer including programs to return cash is the most prudent course of actions while this volatile environment plays itself out.

In the interim we will continue to manage this business in way that my team and I can be proud of and that our shareholders I believe come to expect. Clearly, we will continue to share our current thinking with you on future calls.

So with that operator why do not we open the lines up for questions?

Question-and-Answer-Session

Operator

(Operator Instructions) And your first question comes from the line of Youssef Squali.

Youssef Squali - Jefferies & Company

Thank you very much, good morning.

Kevin Dotts

Good morning.

Youssef Squali - Jefferies & Company

Couple questions, as I guess the first starting with you, Rolla, so in the last 12 months or so, you talked about the possibility of doing some strategic deal one of the targets along the potential partners was AOL or Time Warner. On their call yesterday they clearly continue to explore alternatives as well but they are doing a lot of house cleaning at AOL, arguably have cleaned, you would have been doing to improve that platform. So the question is that platform as attractive to you today as it was 12 months ago, and if not can you, I mean, does that take the dial up consolidation kind of play off the table since the only other player out there is MSN and they don't think to want to be doing much with theirs and the others are too small to really I guess bother with? And then I have a couple questions with, Kevin.

Rolla Huff

I was thinking, there is any question that with the lower number of subscribers it is not as valuable today as it was a year ago. There is just no question about that as I said in my comments you can not go out and recover operating synergies it just, they disappear forever it's like money burning on the ground. I continue to believe that dial up consolidation is the right thing for shareholders in that industry. I do not think that has changed one iota is it as valuable. Your first question, no I do not think it is.

Youssef Squali - Jefferies & Company

I think whether it remains interesting to us going forward. We also had we would upon valuation?

Rolla Huff

I am out of the business in terms of predicting what will happen around this. I think it should have happened a long time ago. I think it's not off the table for us but it's certainly not going to be the thing that we are going to face decisions around.

Youssef Squali - Jefferies & Company

I guess another follow-up to that then, in terms of timing, how do you ideally how would you like to see a play out. It being there use of the cash that you have on hand? And how possible is it that we will be sitting here 12 months from now and you have $750 million on the balance sheet which should obviously great but it would not necessarily help evaluation that much?

Rolla Huff

Yes, I think whether we are sitting here in 12 months which is I think highly unlikely that we would still have that much cash on our balance sheet is really I think driven more by what's happening in the broader economic environment. I think as things start to level off or if things started to improve I think that the building strength that we are currently seeing right now because of our balance sheet would start to decline. As it relates to the industry consolidation, I just think that, that should happen as soon as possible because just, it's what I have been saying, the economics are burning away, it as we don't have consolidation of these platforms value is being lost that can't be recovered. So that should happen as quickly as possible.

Youssef Squali - Jefferies & Company

Okay and than just two quick questions for Kevin. Your CapEx guidance basically implies double enough CapEx spending in '09 over '08. What are you spending the money on or are you just being a little conservative there and should we add up the $535 million in cash that you had at the end of the year is only $58 million of it still in AOS?

Kevin Dotts

Sure, so speaking to the CapEx question, in the past when we are giving guidance that CapEx number has traditionally been both CapEx as well as acquisition cost for subscriber bases and over the year as the opportunity for subscriber bases has declined so our guidance of last year which included a lot more thinking probably on around subscriber based acquisitions is now narrow down the CapEx. So from a change here our guidance that's why it's a little bit more narrow. When I think about why we are going from the $7 million up to guidance of 10 to 20. There are as I talked about I think in the last earnings call.

There are couple of programs that we, milled out that kick in the second half of 2008 and while we had expected to get those programs from a spent perspective underway in the fourth quarter and which is kind of while we held to our guidance, they really didn’t get triggered until really very late in the quarter.

So some of the spending did get done and then we will do more spending. Spending tends to around rewrite of our email platform. We've got some investment that were going into put more surety around our cash flows and our access business with a disaster recovery overhaul. So, there is definitive programs around that, that would suggest that our guidance is inline and not overly conservative.

Rolla Huff

But I think I sort of throw out, that there are still one or two subscriber bases out there that at the right valuation will cause us to actually be over this CapEx guidance. And we are sort of are actively talking to some of these customers but we are very disciplined and what we will pay. If they get right on price you could see that CapEx line go up substantially over even the guidance that we have suggested, but I think the idea of putting it in the plan to acquire these things does not make any sense anymore and I think that's what you heard Kevin say.

Kevin Dotts

I think and that's absolutely right. With regard to your second quarter on the $534 million is actually its $48 million is reflected in that $534 million of the remaining what is it $486 million beyond the $48 million of ARS is ratably liquid.

Youssef Squali - Jefferies & Company

Excellent. Thanks a lot.

Operator

Your next question comes from the line of Jennifer Watson.

Jennifer Watson - Goldman Sachs

Great. Thank you. Rolla, I think on the second quarter call you talked a little bit about some of the complimentary businesses that you would consider, it indicated that in the third quarter you had an opportunity to look at some of these opportunities. Have your view on any of the complimentary businesses that you discussed changed in anyway or it sounds like you think would probably continue to be valuable to EarthLink and you would be able to run very well, or vice-versa and then also any comments or color that you guys have on the stimulus they are providing funding for world broadband roll out if that has any impact in your view on EarthLink’s and your ability to provide more access to US consumers?

Rolla Huff

Sure, I would say that from when we were talking about adjacent businesses in the third quarter, we were taking a throw everything under the microscope and look at what might work, I would say, we narrowed our view down substantially from the list of things that we would think about and we really narrow that to businesses that we are in today, I probably am not enamored around the idea of just jumping into a new business that we had no experience at all in the company just not clear to me that that would make good sense.

What has clearly changed in the, one of the things that we found in the third quarter, as we were looking at some of the businesses that we are in business models that we are in but we round up saying they are not compelling deals is that the valuation differences between our business and their business was. It was just in a completely different zip code. That has been the biggest change over the last 90 days but there are complicated situations out there because these businesses have assets trading at distress level they have got equity holders that still believe that 2006 is going to, is right around the corner again and so its not clear that we get to the finish line on any of these things.

And as I mentioned I know that there is integration risk around whatever we do, but there is no question that potential value to equation to EarthLink has materially changed compared to what it was before this economic crisis. As far as the stimulus bill on rural broadband, we are obviously monitoring that very closely. I would say that, first of all I do not see anything being built and operating for a while as much as we would like to think that by the fourth quarter there going to be these new networks that are built and functioning. I don't have an expectation that would be the case.

We also believe that anything that uses tax payer money to be built will be, will have open access and that we will be able to leverage those networks. So at this point I am frankly Jen, I am trying to get clarity on what happens over the next four to eight quarters and I just do not see that as something that is in that line of site.

Jennifer Watson - Goldman Sachs

Okay, great. Thank you.

Operator

Your next question comes from the line of Mike Crawford.

Michael Crawford - Raytheon

Thanks, just shifting gears a little bit, on New Edge I think last quarter you announced that nice Yum! Brands, I guess hunting license should call it, so --

Kevin Dotts

Yes.

Michael Crawford - Raytheon

I think they have what 17000 franchisees?

Kevin Dotts

Correct.

Michael Crawford - Raytheon

And you how is the hunting?

Rolla Huff

I think the hunting is going well. We are getting a lot of interest in the new products. If most of you probably do not take the time to really pay that closer attention because its such a small part of our business. But, new products that are coming out of New Edge are really having to spend a little time in that industry very interesting especially in this economic environment giving customers the ability to turn off expensive Q1 circuits.

But as we all know from anybody that is familiar with that industry the cycle times around deals are long and when you are in these kinds of environments they get even longer and that what we are experiencing there. And as I say, we are in the business where we can not wish ourselves out of it.

We are in the business, we have got some interesting products and we just got to be very focused on not letting, not letting 2006 cost structures drive 2009 realities. And we focus on that every single day and we are looking at creative ways to leverage those assets in different way. So I just leave it at that.

Michael Crawford - Raytheon

Okay, thanks and then just going back to AOL so, they announced yesterday even though that they are not even focusing on file Internet access. They actually had a lower churn even though its about twice what your churn is, so one how do you try to value, how you try to put a value on that business that’s churning it you twice your rate. I guess that's the first part.

Rolla Huff

No, honestly we are no trying right now. That's the blunt answer, we are not thinking about it anymore, if we are given a reason to think about it anymore.

If we are given a reason to think about it, I think that there are ways to look at what we believe we could do with the base of customers, what programs have work, their customer as for what we know about them, look a lot like our customers.

In terms of tenure and the way they use the product and the way they use the web in general. So, value is always determined by cash flow and synergies. That's how we think about the world, so, I guess there is not a lot more to say other than we are not thinking about it really.

Michael Crawford - Raytheon

Okay, all right. Then you said there is a couple of other subscriber pulls that that might make sense. Are these small enough that you could acquire them with some kind of bounty base, or are they you successfully built them a couple of times, you make a payments so that really reduces your risk or are these larger where you potentially be taking on a little more in the deal?

Rolla Huff

For the most part they are all bounty based that is really what we focused on. There are one or two that are large enough that they might not be bounty-based. One of the thing about doing bounty-based deals, which is probably 98% of the deals that EarthLink has done in the past.

And all of that we did in 2008, for example, were bounty-based deals. But one of the things that happens in the bounty based deal is that you almost drive customer churn, we don't pay for it, because the company that we are buying subs from wind up paying for it, because we only pay them based on what sticks to the network after we forced everybody on to our platform.

It drives down the value to the seller. And for smaller basis, it's just not worth fooling with. We insist on that being the process. There are couple basis out there that are big enough that we might be a little more flexible on, in terms of how we structured the deal but I think that everybody can take some comfort and we are very disciplined about how we think about these things.

Michael Crawford - Raytheon

Okay. Thanks, so then final question is, okay. You mentioned you are not in online advertising campaign and one of the reason, I think they have been doing that as because they have actually seen people move back from broadband to dial up, which is something, I think no never really expected to see in any meaningful way, and have seen any similar metric in your business?

Rolla Huff

I think you mentioned them, I didn't and I just in general, I think their message is right on the money, and I hope they keep it out there on I'm loving. It's great that they are out there doing it.

As I mentioned to you, the metrics that we are seeing in premium dial, the only explanation we can come to is that that has been helped to us. We are not seeing the same help on the value dialed. What we are finding is in the value dial segment is just there are different type of customer, they are being a lot more impacted by what's going on in the economic environment now, but I don't think you should expect us to be doing any national advertising if that was your question?

Michael Crawford - Raytheon

No, my question was have you seen broadband subscribers cancel those accounts to move back to dial?

Rolla Huff

They are not coming off our networks in fact our broadband network back to narrowband.

Kevin Dotts

Again, just to reinforce that out. We haven't seen any marked trend in either, our DSL or our cable products of patents charge is the opposite. There was little in the fourth quarter, but as we come into the January, we are on plan.

The dial up segments are showing and have shown slightly, very slightly higher gross ads, but I think it's very preliminary to make any adjustments there, because as we have always said those early gross ads have this higher churn rates.

Rolla Huff

Although they are coming down, I mean it was really interesting to me that even the early life churn cohorts were there were still high churn in absolute terms, but they were down from prior quarter on the cohort level, which we haven't seen that since I had been here.

Michael Crawford - Raytheon

Right.

Rolla Huff

But Kevin is right it's way too early to call it a trend. I mean we have seen it over the last couple of months, but the way we look at our business, we look at it, we do regression analysis that goes back 150 months. And so we haven't seen anything that's way outside of the volatility that we have historically seen, Good or bad.

Michael Crawford - Raytheon

Okay, great. Thank you.

Rolla Huff

Sure.

Operator

Your next question comes from the line of Scott Kessler.

Scott Kessler - Standard & Poor's

Alright, thanks a lot. Well since it seems that you guys are not as focused on a large scale consolidation in the ISP space, obviously you still have that $500 plus million on the balance sheet.

I guess I just wanted to know what your latest thinking on that and maybe a sense of timetable about potential decision, at least relative to some of that capital. Obviously people are wondering whether or not you might step up the share repurchase, whether you might initiate some kind of dividend activity, I guess some insight into that would be great? Thanks.

Rolla Huff

Sure. As I tried to walkthrough in our comments, the way we are thinking about it is that, the world is changing so quickly and has changed so quickly over the last 90 days that it has clearly caused us to pause from our path that I think we were generally on.

As we look at some of these companies that just couldn't have been in our sites 4, 5 months ago, because of valuation differences and because they were just in a different place.

Now they are within reach. I don't know whether any of them will wind up being actionable or compelling enough to pass the hurdle of our next best alternative, which is a pretty good one, which is to keep our cash and begin program of returning.

As I said, as a shareholder that's sounds like a pretty good alternative to me. But I also understand that dislocation that is happening all around us has put us in a different position than we were in just 90 days ago, and it's a significantly different position.

As you are asking about timeframes and as I tried to mention, I think that if we see the economic environment stabilize and begin to improve, I think that will probably reduce the timeframes that would have us starting a program to return cash.

If they get continually worse, I think the potential value of some of these things actually expands and I think that would probably hold us up a little bit more, but we just simply don't believe that now is the right time to put a stake in the ground and say this is what we are going to do.

Kevin Dotts

Scott, I would also add that I mean we still have a $169 million approved by our Board for share buybacks, and we have had a lot of dialogue on that subject and I think we are certainly prepared at the right level to go out and buyback stocks, so we haven't stop that program, but we are just being very judgmental about it, because we do believe our cash is a strategic weapon.

At the same time, we were really monitoring closely the fourth quarter and all the dislocation going into the debt markets, and we have been very clear. We are willing buyer of our debt if they can return a very low-risk, high yield back to our shareholders, but quite frankly our pricing on a debt did not look like a lot of other companies that we were trading in the $30 to $50 range, or that stayed up relatively strong. And in fact has traded over 100 again, so we just haven't been able to avail ourselves with great opportunity there.

Rolla Huff

Yes, Scott, I just think it's really important for you and for others on the call to understand that nothing has been taken off the table. We are looking for ways to leverage what's going on around us, and there are lot of different ways to leverage this environment given where we are and the hard work that we put into get where we are.

So, all of you are hearing us saying is. And by the way, many of the people on this call and our larger shareholders have, I think, the feedback that they given me is the same is that you have to ought to see how this plays out a little bit, because the world is changing all around us. But I think you can be confident that we are not leaking cash any place.

Scott Kessler - Standard & Poor's

Okay. Thanks a lot.

Operator

And there are no further questions at this time.

Kevin Dotts

Okay. Well, I would like to thank everybody for joining us. This is a topic that will continue to stay current. You will continue to hear us talking about it in the coming months and quarters. So thanks for joining us and we look forward to talking everybody a little bit later. Bye, bye.

Operator

Thank you for participating in today's conference call. You may now disconnect.

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Source: EarthLink, Inc. Q4 2008 Earnings Call Transcript
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