EarthLink, Inc. Q2 2006 Earnings Conference Call Transcript (ELNK)

EarthLink, Inc. (ELNK)
Q2 2006 Earnings Conference Call
July 20, 2006 8:30 am ET

Executives

Kevin M. Dotts, CFO, EVP
Charles G. Betty - CEO, President

Analysts

Youssef Squali - Jefferies & Co.
Jennifer Connolly - Goldman Sachs
Heath Terry - Credit Suisse
Bryan Goldberg - Bear Stearns
James Friedland - Cowen & Co.
Keith Dalrymple - New York Global Securities
Matt Dock

Presentation

Operator

Good morning. My name Kevin and I will be your conference operator. At this time I would like to welcome everyone to the EarthLink second quarter 2006 earnings conference call. (Operator Instructions) Mr. Dotts, you may begin your conference.

Kevin M. Dotts

Thanks and welcome, everyone, to our call. This morning I’m joined by EarthLink CEP Gary Betty and our Vice President of Investor Relations Mike Ballantyne to discuss our second quarter 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 protections afforded 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 principal 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 investors, our comments today also included 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 8K that has been furnished to the SEC, both of which are available at our web site at www.earthlink.net.

Now, I’ll turn things over to Gary.

Charles G. Betty

Thanks, Kevin. I’d also like to welcome everybody to our earnings call. In the second quarter of 2006 EarthLink continued to execute on its strategy to become a total communications provider.

On May 2, Helio officially launched its innovative wireless service across both the Helio and Helio Powered by SK Telecom brands.

Helio’s flagship service includes an exclusive service, MySpace Mobile on Helio, as well as [Java] mobile, 3D and multiplayer games, video streaming and downloads plus video, picture and text messaging.

Helio Powered by SK Telecom flagship service includes international Korean language text messaging, Korean language content and Korean language customer care. These services were locked on the Hero and Kickflip handsets. Both of these devices are unique to the U.S. market.

Helio’s still in the process of expanding its distribution footprint, but already the service is available at more than 1,100 locations around the country, including Tower Records, Fry’s, FYE and wireless agents as well as online at helio.com.

For the remainder of 2006, Helio will continue to expand its distribution channels and device offerings. In fact, just last week Helio launched TV and radio advertising in key cities like Chicago, Los Angeles and San Francisco. Plus, print advertising in national and regional magazines is occurring as we speak.

During the quarter we continued to market our bundle of 8.0 megabit per second DSL and home phone service in Dallas, Seattle, San Francisco and San Jose. In these markets, we continue to test a variety of different offers and creative concepts for promotions across a variety of channels. Recently we have temporarily opened a retail store in Seattle and San Francisco in high-pedestrian traffic areas to test some additional retail sales concepts. Further, in July we’ll promote this service to a leading retail electronics chain in certain of these markets to test additional sales strategies.

Our goal is to be able to quickly expand and increase our sales efforts across a variety of channels in the eight additional markets that [Cidco] is building out to provision line-powered voice by the end of the third quarter of 2006. By the fourth quarter of 2006 we’ll be able to actively market these services to over 10 million households and they should be able to more meaningfully contribute to our subscriber and revenue growth.

In the second quarter of 2006 we continued to market EarthLink’s True Voice Over IP solution, primarily through direct mail and emails. In the third quarter EarthLink expects to expand the distribution channels to include the national and regional speciality retailers including Best Buy, Circuit City, Fry’s, Office Max and Micro Center. Together these retailers accounted for 90% of the voice phone services sold in the U.S. in 2005. As we’ll be expanding into these retail locations during the quarter we expect EarthLink True Voice to only modestly contribute to customer growth in the third quarter.

We expect a seasonally strong fourth retail quarter, Christmas-selling season, to more fully contribute to subscriber and revenue growth.

During the second quarter we also expanded our municipal Wi Fi footprint by winning the right to unwire the city of New Orleans. Also on June 29, we officially launched our first municipal broadband network in Anaheim, California. The initial launch area is approximately 10 square miles. We expect to have the entire 49 square miles completed by the fourth quarter.

During the second quarter EarthLink also initiated construction of the municipal Wi Fi network in the city of Philadelphia. We expect to have the first phase of this city-wide build-out completed by the end of the third quarter.

Since we have a limited coverage area as we continue to build out the municipal Wi Fi network during the third quarter in both Anaheim and Philly, EarthLink expects to generate only marginal subscriber demand. However, in the fourth quarter we expect a more materially impact to subscriber demand in these markets.

In the second quarter EarthLink also completed the acquisition of New Edge Networks. We’re now working to assist New Edge in expanding and increasing their sales and marketing efforts to more fully participate in the U.S. IP VPN market, which is expected to grow at over 20% [inaudible] through 2009. However, because of the lengthy sales and installation processes involved in selling IP VPNs to enterprise customers, in 2006 we do not expect material growth from New Edge. We do expect them to more fully contribute in 2007 and beyond.

For our existing Internet access services, we continue to grow in the value narrowband and broadband area while declining in the mature premium narrowband space.

In the second quarter our value PeoplePC brand added 48,000 net subscribers to end the quarter at 1.4 million, a 34.8% increase from the second quarter of 2005.

We also continued to generate solid growth in our broadband services. For the quarter EarthLink added 116,000 net broadband subscribers, which included 58,000 New Edge Network circuits.

We ended the quarter with 1.8 million broadband subscribers, an increase of 21% compared to the second quarter of 2005.

During the quarter, our premium narrowband subscriber base decreased by 163,000, to end the second quarter with 2 million subscribers. At the end of the second quarter, only 37% of our customers were premium narrowband subscribers, down from 50% just one year ago and that number is expected to continue to decline. By the end of 2006 our traditional premium narrowband subscribers should account for only about one third of our [ending] subscribers.

Meanwhile our broadband subscribers now account for 34% of our customers. That’s up from 28% in the second quarter of 2005. If current trends continue, next quarter for the first time EarthLink will have more broadband subscribers than premium narrowband subscribers.

I’d now like to turn the call over to Kevin to discuss our financial results.

Kevin M. Dotts

Thanks, Gary.

In the second quarter of 2006 our existing Internet access services continued to generate consistent amounts of EBIDTA and free cash flow compared to 2005. This EBIDTA and free cash flow from the access services was partially reinvested in our various growth initiatives to generate revenues earnings growth in future periods.

Broadband revenues were $144.4 million, a 28.8% increase compared to the second quarter of 2005, primarily due to the addition of New Edge Networks.

Narrowband revenues were $157.4 million, a 16.5% decrease compared to the second quarter of 2005. The decrease in narrowband revenues was primarily due to the decline in premium narrowband subscribers, partially offset by the subscriber growth in our value brand, PeoplePC.

For the second quarter of 2006 advertising, other value-added services and web hosting revenues continued to be a strong growth area of EarthLink, increasing 20.4% to $30.3 million compared to the second quarter of 2005. This revenue growth was due primarily to an increase in search-related advertising and value-added service revenues. These value-added services now generate a record $1.36 in incremental revenue per average user per month compared to $0.92 during the second quarter of 2005, a 48% improvement.

Overall, revenues for the quarter were $332 million, a 2% increase from second quarter of last year, driven primarily by the increase in broadband revenues and advertising, other value-added services and web hosting, partially offset by a decline in premium narrowband revenue.

As EarthLink continues to evolve into a total communications company and away from a premium narrowband access provider, our reliance on premium narrowband revenues continues to decrease. During the second quarter of 2006 only 34% of our revenues were derived from premium narrowband services, down from 47% in the second quarter of 2005. Broadband revenues now account for 43% of our revenues in the second quarter, up from 34% in the second quarter of 2005. By the end of 2006, premium narrowband revenues are likely to account for less than 30% of our total revenue while broadband revenues are expected to be approaching 50% of total revenue.

Our narrowband and broadband gross margins have improved significantly over the past few years. Narrowband gross margins are almost 90%. Broadband gross margins, including New Edge Networks, are in the mid 30% range. With the greater proportionate share of revenue moving to lower margin broadband, overall gross margin percentages, however, declined to 66%, down from 71% in the second quarter of 2005. Consequently gross margins were $220.3 million, down 4.5% compared to the second quarter of 2005.

Total operating expenses including sales and marketing were $190.1 million, an increase of 5.8% compared to the second quarter of 2005. However, included in the second quarter of 2006 expenses, and not included in 2005, is approximately $3.7 million of stock-based compensation expense related to FAS 123R, which was adopted on January 1, 2006.

Additionally, the second quarter of 2006 includes approximately $30 million of expense related to the ramp up of our voice, muni Wi Fi and New Edge Networks growth initiatives. We expect to benefit from these growth initiatives in future periods.

Adjusted EBIDTA was $39.3 million, a 34.7% decline from second quarter of 2005, driven primarily by a decrease in gross margins coupled with higher operating expenses related to our various growth initiatives.

Net income in the second quarter was $16.6 million, or $0.12 per share, a decrease of $27.3 million compared to the second quarter of 2005.

The decrease in net earnings is primarily attributable to a $20.8 million decrease in adjusted EBIDTA noted previously, a $13.3 million increase in equity losses related to the Helio joint venture as Helio continues to ramp up its operations, and a $3 million decrease in gain on investments in other company’s, net.

These were partially offset by $8.2 million decrease in income tax expense, which was primarily due to no income tax expenses being reported during the second quarter of 2006 and a $1.4 million increase in interest income and other, net, related to interest earned on investments in cash and marketable securities.

EarthLink generated $31.5 million of free cash flow during the second quarter of 2006.

Capital expenditures and cash payments for previously acquired subscriber-based acquisitions in the second quarter aggregated approximately $7.6 million.

We re-initiated our share repurchase program during the quarter and purchased 2.3 million shares of EarthLink common stock for a total of $19.5 million. We have $160 million remaining under the repurchase program as of the end of the quarter.

Also during the second quarter as previously noted, we completed the New Edge Networks acquisition. As a result net cash paid was $109 million, which included transactional costs.

Lastly in the quarter, EarthLink invested $10 million to a funding round for Current Communications. Current Communications, a privately-held broadband-over-power-line service provider, will use the capital raised to build-out broadband-over-power-line networks in the Dallas, Fort Worth area. Once these networks are completed in 2007 and 2008, EarthLink will be able to market a VPPL broadband-over-power-line Internet access service to approximately 2 million households.

During the second quarter of 2006, cash and marketable securities decreased $116.5 million and we ended the quarter with $236.3 million of cash and marketable securities.

Now for the outlook.

The following statements are based on management’s current expectations. These statements are forward looking and actual results may differ materially. The company undertakes no obligation to update these statements.

As a result of revised customer demand projections and customer and product mix revisions, EarthLink now expects full year 2006 revenue of $1.3 billion to $1.33 billion.

Additionally related to these revised customer expectations, EarthLink is refining its expected adjusted EBIDTA to be $120 million to $130 million for the full year.

We are also revising our expected proportionate share of Helio’s equity method losses to be $75 million to $85 million.

As a result EarthLink now expects full year net income to between breakeven and $20 million.

In the third quarter of 2006, EarthLink expects net subscriber additions to be between breakeven to a loss of 25,000 net subscribers.

Revenues are expected to be between $330 million to $335 million.

Adjusted EBIDTA is expected to be between $25 million and $30 million.

Net income is expected to be between breakeven and a loss of $10 million.

This income guidance includes our proportionate share of Helio’s expected equity method loss of $20 to $25 million as Helio continues to increase its marketing efforts in the quarter.

With that, I will turn the call back over to Gary for some concluding remarks before our question-and-answer session.

Charles G. Betty

Thanks, Kevin.

The second quarter was very important for EarthLink. Our existing access services continue to deliver the financial results to enable EarthLink to invest in our strategic growth initiatives.

Helio successfully launched their [inaudible] services, we launched our municipal Wi Fi service in Anaheim and won the opportunity to deploy a municipal Wi Fi network in the city of New Orleans.

EarthLink also successfully completed its acquisition of New Edge Networks, enabling us to expand in the fast-growing U.S. IP VPN enterprise market.

Finally, in the voice services arena, we continue to test and learn so we can efficiently and effectively increase marketing as [Cidco] completes additional line-powered voice market build-outs.

As EarthLink moves to the third quarter and beyond we’ll be expanding our footprints for municipal Wi Fi and bundled voice and data services, and expanding our distribution channels for voice and New Edge Networks. Helio will also continue to expand distribution, brand awareness, device choices and service offerings to better address their customer needs and wants.

Finally, we expect existing access services will continue to perform and deliver to enable EarthLink to fully capitalize on these strategic initiatives.

I’ll now turn the call over to the operator to set up the line for questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question is from the line Youssef Squali.

Youssef Squali - Jefferies & Co.

Thank you very much. Good morning, Gary, Kevin and Mike. So, a couple questions. First, I want to go back to the New Edge Network. You said something interesting. You said that you do not expect material growth from New Edge. First of all, can you quantify the contribution of New Edge to the quarter and also I thought, I was under the impression that when the deal was closed you had seen a nice pickup of some new customers coming into it. Why the conservative outlook right now.

Charles G. Betty

I’ll take the first part of it. Kevin could give you what the contribution was. It’s a question of timing. Our backlog, our pipeline has increased nicely, sales are ramping but you’re talking about adding $100,000 or $200,000 net new revenue per month so – and it takes four or five months for you to close some of these very complex networking deals so we are very encouraged about the activity that we’re seeing in New Edge. It’s going to have a much bigger impact on next year’s results as these efforts start to actually show up in the monthly results that we report to you each quarter.

Kevin M. Dotts

Youssef, this is Kevin and again, as Gary [indicated], it’s just a matter of timing as they start their marketing efforts that the actual growth then comes in over a three to six month period after the spending occurs, which is a little different than our consumer.

Charles G. Betty

But I am very happy about the level of activity and the things we’re seeing in terms of backlog.

Kevin M. Dotts

Absolutely. To you question on contribution, they were roughly in the $28 million of revenue on a partial period for the quarter so that’s about, say 10 weeks out of 12 based on the timing of the close.

Youssef Squali - Jefferies & Co.

Can you speak to their margins?

Kevin M. Dotts

Favourable gross margins in the mid 30 range at this point.

Youssef Squali - Jefferies & Co.

How about operating?

Kevin M. Dotts

I’m not sure we take that through the operating at this point. From a contribution margin basis, I think at this point they’re roughly breakeven.

Youssef Squali - Jefferies & Co.

Okay, and then on PeoplePC, you’ve added 48,000 which is noticeably lower than what you had in Q1. It was 125,000 in Q1, 59,000 in the same period last year. Are we getting to a point where it’s becoming difficult to kind of fight a lot of gravity and becoming –?

Charles G. Betty

No, I think part of it’s timing. Part of it, we got a little bit of – in Q1, we got a little bit of a tailwind from the AOL price increase that came out. Part of it, we had a little bit of higher churn in Q2 due to an acquisition that we made the previous period. But PeoplePC is doing fine. I think you’ll continue to see pretty consistent growth out of that group, at least through the rest of the year and next year and, you know, hopefully we’ll see some even better performance in terms of net adds on a go forward basis.

Youssef Squali - Jefferies & Co.

Okay, that’s great, and then lastly, can you speak a little bit about, so Helio has been out for a little bit. Granted, it’s very early but I’ve [noticed] two things. One is your loss from the Helio partnership you’ve lowered a little bit. I wonder if that’s an indication that things are going a little slower than expected.

Second, if you can touch a little bit on the – is it too early to kind of have an idea as to what [sales] could be?

Charles G. Betty

It’s too early. I mean, we’ve only been selling in the SKT, the Korean market, for 7 weeks. We’ve been selling really Helio for 6 weeks, but all that’s been, most of it’s been passive demand. So I think we’re encouraged that the product is getting great accolades. It continues to get a lot of very good buzz for the types of innovative services they’re bringing to the marketplace and they’re working diligently to build-out and start increasing the productivity of the sales [inaudible] they’re bring out. So we really won’t have anything meaningful in terms of how the ramp is and what kind of trends are until we [execute in Q4].

Youssef Squali - Jefferies & Co.

Okay. That’s great. Thanks a lot.

Operator

Your next question comes from the line of Anthony Noto.

Anthony Noto - Goldman Sachs

Hi.

Operator

Mr. Noto, your line is open.

Jennifer Connolly - Goldman Sachs

This is Jennifer Connolly on for Anthony Noto. Okay, you guys can hear me now. My question is related to AOL’s plans to offer Internet value-added services, some of their premium offerings, for free and how do you think that will impact your subscriber base and people’s willingness to pay for the value-added services that EarthLink provides versus other Internet access providers?

Charles G. Betty

Well, I think AOL – you know, I don’t know exactly what AOL intends to do obviously, but as I understand it they are trying to evolve more to a portal business model than access it. In order to use those services, you need some underlying access for that. So I think in some instances if they really move away from providing access to users, that could be a windfall for our company. They’ve got to get it from somebody; why not us?

Jennifer Connolly - Goldman Sachs

Right. But do you think people will pay up, because typically, I mean, when you look at EarthLink’s price offering versus the competitors’, do you feel that you typically have a premium pricing in order for –

Charles G. Betty

I don’t – in the VSL market, we’re very competitive most of the time at this point. Some of the phone companies have a lower promotional offer than we do up front, but after 12 months our prices are very competitive with what’s available in the marketplace so no, I don’t see us changing a lot. You know, our value-added services more are a function of usage than they are – they’re paying something incremental on top of what already is being provided to the consumer. So, you know, I don’t see a whole lot of change. It’ll be interesting to see how that whole strategy develops as they release the details of exactly how they’re going to try to accomplish that.

Kevin M. Dotts

Yeah, and the only thing I think we’ve seen speculated in the papers, like everybody’s else has seen, is the broadband.

Charles G. Betty

Right. They’ll walk away from the BYLA.

Jennifer Connolly - Goldman Sachs

Right.

Kevin M. Dotts

Broadband so, you know, that’s not to suggest they’re walking away from the premium, dial up product.

Jennifer Connolly - Goldman Sachs

Right. Then also, just sales and marketing relative to our expectations came in rather light and I was wondering if there was anything that you guys pulled back on marketing spend this quarter, didn’t spend as much as you had anticipated originally, if there were any delays in spend related to certain product rollouts.

Charles G. Betty

No, as we’ve talked about in the past, Jen, ours is success-based marketing. We had a long discussion about this in Vegas and it’s all demand-creation related, premium [dial-up] in particular has continued, I think we’re down probably 50% year over year in terms of the number of new [inaudible] that we’re bringing in at a [mac] that we find acceptable and that drove more of the spend than not. We do expect that spend to increase consistent with the guidance we provided for Q3 and for the rest of the year as we have more markets to sell our home phone service with DSL, EarthLink True Voice and our muni Wi Fi, those expenses will start increasing as we ramp the demand creation efforts associated with those product lines.

Jennifer Connolly - Goldman Sachs

Okay and then just one final question. Could you provide an update to the full year sub numbers? [Sub addition] numbers?

Kevin M. Dotts

Well, we’ve left that Jen the same, between 50,000 to 75,000 net subs.

Jennifer Connolly - Goldman Sachs

Thank you.

Charles G. Betty

Which obviously means we’ll have a reasonably strong fourth quarter.

Jennifer Connolly - Goldman Sachs

Right. Thank you so much.

Charles G. Betty

Thank you.

Operator

Your next question comes from the line of Heath Terry.

Heath Terry - Credit Suisse

Great, thanks. Sorry about that. I was wondering if you could talk a little bit more about what you’re seeing in the early days of Anaheim. You had kind of mentioned that as soon as you started lighting up parts of the network you were seeing people hitting it, trying to log on. Have you seen those trends continued and have those actually turned into subscribers, realizing that we’re just talking about 10 square miles right now?

Charles G. Betty

Ten square miles around City Hall.

Heath Terry - Credit Suisse

Okay, and then if we go –

Kevin M. Dotts

[Inaudible] subscribers, I mean, we’re adding subscribers every day.

Charles G. Betty

The network is performing very well. The customers that are on the network right now are ecstatic with the performance, obviously. There haven’t been any technical glitches to speak of and we’re continuing to build out. We won’t know a whole lot. The occasional use model will be much better understood as we build out the area around Disneyland that wasn’t part of the initial 10 square miles that was open, so we are seeing some occasional use but once we get that built out around the Disneyland complex, we should see that spike significantly.

Heath Terry - Credit Suisse

And you mentioned that the entire 50 square miles would be done, 49 would be done by the end of the year. Is Disneyland in the Q3 part or the Q4 part?

Charles G. Betty

I don’t even – off the top of my head, I don’t know.

Heath Terry - Credit Suisse

Okay. Also if you could talk about the line-powered voice offering. Those four markets that you’ve been in. I know you’re still testing a lot of the marketing now.

Charles G. Betty

Very encouraged. We’re having good success, both on the entry level offer, upgrading our dial-up and PeoplePC dial-up customer base and upgrading our DSL subscribers. We’re staring to see penetration rates consistent with what I think would characterize success. It’s about .1% market penetration per month in those four markets and we still haven’t, I mean Fry’s, for example, we were a little bit late coming up. We actually didn’t start our comprehensive Fry’s stuff until the second, the third week in June, so for last quarter it contributed very little to net overall results.

But some of the tactics that are working well: door to door, telemarketing. Door to door sales are working reasonably well. Our [inaudible] marketing efforts to our base are working well. Our direct response worked to our customer base is doing well. We’ve got a lot of buzz from the [pop-up] stores that we put in place in Seattle and San Francisco. We’ve done sidewalk art. We’ve done wrappers. There’s a lot of local market things that we’re doing to augment creating, demand creation.

And I think the early reads back is that it’s starting – people are, the awareness that we’re offering to service in those markets is responding. So I’m very encouraged that as we get access to these other 8 million homes, we should see a significant step up in terms of the overall customers and think about it – there’s 10,000 of these ads in a month represents $7 of new revenue annually. So it’ll start having a meaningful impact on a monthly basis. And [definitely start] having a meaningful impact on revenue growth as we look out to future periods.

Heath Terry - Credit Suisse

And, I mean, are there any numbers that you can put around that at this point in terms of subscribers?

Charles G. Betty

Not beyond, I mean, obviously with a 50,000 to 75,000 net growth of customers for the year we expect to see some pretty strong growth both on the voice side and on the muni side for Q4.

Heath Terry - Credit Suisse

Okay, and then you mentioned having all eight of the additional markets rolled out by the end of Q3.

Kevin M. Dotts

End of October.

Heath Terry - Credit Suisse

Okay. By October. New York still on track for August?

Charles G. Betty

A big part of New York will be on track for August. I’m not sure exactly that all the COs are going to be built out but in August and September, a lot of these markets will start [going online].

Kevin M. Dotts

Sounds like a potential customer [inaudible].

Charles G. Betty

Right.

Heath Terry - Credit Suisse

Absolutely. Thanks a lot. I’ll be keeping my eye out for the EarthLink wrappers.

Charles G. Betty

All right, Heath. Thank you.

Operator

Your next question comes from the line of Bryan Goldberg.

Bryan Goldberg - Bear Stearns

Good morning. I just had two quick questions. I didn’t see mention of Capex guidance for the full year of 06. Are you reiterating your previous guides for Capex? Your muni Wi Fi win in New Orleans, is there any Capex associated with that win? And also on your broadband reported subscribers, are the EarthLink True Voice subs included in that count and if so, I was just wondering, could we get a rough sense as to how many you have?

Kevin M. Dotts

From a Capex guidance perspective, I think we’ve previously been kind of in the 80 to 100 range and I think were guiding still within that range at this point, Bryan.

The New Orleans build out was, as we had expected to launch in multiple markets this year, that’s just kind of filling in one of the product plans so I think that’s all within line.

Charles G. Betty

Part of the guidance we previously provided. On the number of subs, I think we finished the quarter with 20,000 voice subs.

Bryan Goldberg - Bear Stearns

Okay, thank you.

Operator

Your next question is from the line of Jim Friedland.

James Friedland - Cowen & Co.

Thanks. Most of my questions have been answered so just two quick ones. First on the broadband numbers, 116,000 net broadband subscribers in the quarter. I’m assuming that includes some New Edge customers. If you could break out the New Edge and just give us what the pre New Edge number would be, and then on stock-based comp, is the stock-based comp expense imbedded completely in the G&A line or is it going to show up anywhere else as well? Thanks.

Kevin M. Dotts

Yeah, Jim. This is Kevin Dotts. The New Edge Network piece to that total broadband added subscribers was 58,000 circuits and as far as SFAS 123 expense of $3.7 million is per FASB being booked across our G&A and other op ex lines, including sales and marketing to more or less of a degree.

Kevin M. Dotts

We allocated it because of where the headcount is effectively, expenses are allocated, too.

James Friedland - Cowen & Co.

Okay, and so I just would assume that it would be weighted in G&A for, like, corporate overhead and then is it pretty-much even across all three?

Kevin M. Dotts

It’s – actually, you know what? I’ve looked at this, I think, based on our last discussion last quarter and it’s relatively balanced across G&A, sales and marketing and op ex.

James Friedland - Cowen & Co.

Okay, great. Thanks.

Operator

(Operator instructions) The next question comes from the line of Keith Dalrymple.

Keith Dalrymple - New York Global Securities

Hi. I have a couple of quick questions here. One, on line-powered voice, you guys have been doing a lot of testing of marketing methods in the four markets. When you start rolling out with the new market starting in August do you anticipate that the test period will be over and that you’ll basically be going into all your markets more or less full steam?

Charles G. Betty

We’ll have a much more aggressive push in some of the things, particularly our ramp up in distribution channels; ramp up of door to door sales would have been done, it’s just a matter of getting the people on the street to do so.

Keith Dalrymple - New York Global Securities

Okay, terrific. And in terms of muni Wi Fi, I know that you had mentioned a little earlier, Gary, that you haven’t hit any technical glitches so for. Has the indoor performance been adequate?

Charles G. Betty

Very adequate. More than adequate. It’s great.

Two issues on indoor performance. One is the type of system that you’re using to transmit. Most of the houses can [see] the signal without any special [CPE] but if you have a certain type of laptop with a low-power Wi-Fi chip set, the transceiver may not be powerful enough to transmit the signal back through walls so you may need some type of signal insinuator to do that depending upon your configuration and what type of PT. I know the latest Macintosh computer that came out has a very weak receiver. It was designed to work over just an 80211 gateway in the house, not to transmit signals back to a [robust] radio on a light pole. But we have [TP] to fix that so receiving signals are okay, transmitting signals, you may need to do that. We still think that we’re going to be able to provide 90% to 95% indoor coverage for the areas that we’re servicing.

Very encouraging stuff.

Keith Dalrymple - New York Global Securities

Okay, so there’s been no significant technical hurdles there?

Charles G. Betty

At all.

Keith Dalrymple - New York Global Securities

Could you tell me what will be the square mile size of the New Orleans network?

Charles G. Betty

Twenty.

Keith Dalrymple - New York Global Securities

Twenty square miles.

Charles G. Betty

We were going to do 10 but we picked up 10 square miles in New Orleans plus the airport, plus we picked up two very attractive neighbourhoods that are surrounding this initial area, also wanted to get built out, which we agreed to do.

Keith Dalrymple - New York Global Securities

Okay. Do you have any idea what the population of that area is?

Charles G. Betty

There’s 130,000 FEMA workers.

Keith Dalrymple - New York Global Securities

Okay.

Kevin M. Dotts

The one thing we can add, I would add to that, Keith, is we also have optionality to continue to build out further as people relocate back into the New Orleans area.

Charles G. Betty

It’s a hard number to get to, but I think it’s around 100,000.

Keith Dalrymple - New York Global Securities

Okay. And lastly, could you comment generally about the RFP process with other municipalities? In my opinion, I expected them to roll out a little more quickly and to have municipalities make decisions a little more quickly than they have and it seems to me they have –

Charles G. Betty

Amen, brother.

Keith Dalrymple - New York Global Securities

The Q1 timeframe, maybe municipalities became a little obsessed with trying to get free service but that seems to have tapered off. Could you just comment on the interest level?

Charles G. Betty

We’re finalists in five cities. We’ve built out a one-square mile test bed in Minneapolis that’s going well. We have RFPs in various stages at about 25 others so, Keith, I would characterize it this way. It’s a little bit slower getting the contract completed and built, but the level of interest and the number of RFPs that we’re seeing is much greater than I expected at this point in time.

Kevin M. Dotts

Just recently we had Atlanta –

Charles G. Betty

Atlanta issued an RFP. Chicago issued an RFP. LA has had their first meeting. All of these, and the big cities in particular, it’s going to be a very contracted and drawn-out process just because you’re dealing with a large bureaucracy. The first meeting we had with the city of LA, there were like 60 different government entities showing up at the pre bidding conference. Sixty! So it’s going to be an interesting thing. Some of the smaller municipalities, like Anaheim, that went very smoothly. We did that from start to finish and we’ve gotten a lot of interest from other, sister parts of the Orange County area that are interested in EarthLink doing something similar for them as well.

Keith Dalrymple - New York Global Securities

All right. Thank you. That’s helpful.

Operator

Your last question comes from the line of [Matt Dock].

Matt Dock

Yes, I’ve got a couple questions. I’d like to know what you’ve learned from marketing the line [inaudible] in the test markets, particularly pricing.

Charles G. Betty

Two things. One, they are two very separate markets that we’re addressing. One, you lead with this $49.95, 1.5 meg, 500-minute service and that, for people who are value sensitive, seems to really catch their notice. It’s price driven.

For early adopters and people that have had a relationship with EarthLink, the 8 meg all you can eat for [$69.95] seems to resonate the greatest. So we’re seeing very much striation in this marketplace, one value-oriented, one feature and capability orientation, and both are doing quite well.

So I’m please [across the process]. We’re still having a little bit of a challenge. Our biggest single challenge in getting [some of the same] LNP process, the line number portability. You’re still talking about having someone turn over their lifeline voice services to someone, particularly for non EarthLink customers, that’s a little bit of a leap sometimes if they aren’t familiar with who we are and have had a relationship [over a period]. But we’re working through those issues and the more people that have it and the more [bodies] you get, I think the easier those challenges will be to overcome.

Matt Dock

Okay. What are you doing to improve customer service without spending large amounts of money?

Charles G. Betty

That’s kind of like, is my child ugly? We think we have great customer service. When you roll out a new service like line-powered voice or EarthLink True Voice, we are going to have instances where some customers get stuck in the process, but we learned a lot as we rolled out DSL in the 1999/2000 range. I can promise you, where we are today in terms of being able to consistently provide high-quality services is significantly better than the same place we were in the 2000/2001 timeframe from broadband. I think about 75% of the customers who order one of our voice services go through without too much difficulty. Twenty-five percent we have to babysit a little bit. The process still takes too long, particularly if you’re not what called [ebonded] telephone company because the LNP process, if you’re working with some of the telephone companies, they’re independent, it can take as long as 30 days.

So as part of the experience that we’re still working through to make it better and better and improve and streamline the processes. But in general, I’m pretty pleased with where we are at this point.

Matt Dock

Okay, great. Thank you.

Operator

At this time there are no further questions.

Charles G. Betty

All right. Thank you all for joining us for the conference and we look forward to sharing with you our continued efforts to build these new businesses and transform the company into a total communications provider. Thank you.

Operator

This concludes today’s EarthLink second quarter of 2006 earnings conference call. You may now disconnect.

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