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EarthLink Inc, (NASDAQ:ELNK)

Earnings Conference Call

July 27, 2010 08:30 am ET

Executives

Brad Ferguson – Chief Financial Officer

Rolla Huff - Chairman & CEO

Joe Wetzel – Chief Operating Officer

Michele Sadwick – Vice President, Corporate Communications

Louis Alterman – Vice President, Investor Relations

Analysts

Youssef Squali - Jefferies & Co.

Ingrid Chung - Goldman Sachs

Mike Crawford - B. Riley & Company

James Cakmak - Sidoti & Co.

Sri Anantha - Oppenheimer

Scott Kessler - Standard & Poor’s Equity

Rick D'Auteuil - Columbia Management

Presentation

Operator

Good morning everyone and welcome to the EarthLink second quarter 2010 earnings conference call. Today’s call is being recorded. At this time I would like to turn the conference call over to Mr. Brad Ferguson Chief Financial Officer for opening remarks and introductions. Please go ahead sir.

Bradley A. Ferguson

Thanks and welcome to our call. This morning I’m joined by EarthLink’s Chairman and CEO Rolla Huff, our President and Chief Operating Officer Joe Wetzel, our Vice President of corporate Communications Michele Sadwick and our Vice President of Investor Relations Louis Alterman to discuss our second quarter 2010 results and updated 2010 guidance. Following our comments there will be an opportunity for questions.

Before we continue I’d 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 describes in the forward looking statements that are not intended to represent a complete list of all the risks and uncertainties impairment to the company’s business.

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

Now I’ll turn things over to Rolla.

Rolla P. Huff

Thanks, Brad and good morning everyone. I’m pleased to report that our second quarter financial and operating results were once again ahead of our internal expectations.

During the quarter we continued to build on the positive momentum we discussed with you on our last call in April. At that time we highlighted 3 key themes in our business and today those same themes are equally relevant.

I’d like to review those 3 key topics and I’ll provide you with a quick update on each. First when we reported our first quarter results that were ahead of expectations we discussed how that steamed from a number of positive changes in key underlying business drivers that created what we described at the time as a positive feedback loop driving better results than our historical trend lines had predicted.

In April we raised our guidance to reflect the new trend lines.

In the second quarter we experienced even further net improvement which is also extended into July I might add. Across many of the same areas including customer churn, network performance, customer contact rates, bad debt as well as a new area or two including our search and advertising revenues.

Essentially we outperform the revised trend lines as a result we reported second quarter adjusted EDITDA of $57 million and today further increased our 2010 guidance.

The second theme we talked about last quarter was the fact that we run our core internet access business as a cash generation vehicle and will not pursue growth at any cost.

While the top line is declining it continues to do so at an attenuating rate. We maintain our belief that continuing to execute on our cash generation strategy will maximize shareholder value. And I think clearly we believe that today’s result and higher guidance continue to validate that strategy.

The third major theme reinforces that we continue to be vigilant stewards of our balance sheet while we seek investment opportunities that allow us to apply our skill sets, company assets and business discipline in value creating way.

We continue to believe that the strategic leverage of our balance sheet will even flow with the strength of the debt and equity markets. As the equity markets weaken the relative strategic leverage of our balance sheet strengthens. We believe our balance sheet currently represents a relative strength.

So with those key things in mind let me spend a bit more time on some of the trends we saw in the second quarter and the actions our team has taken to maximize cash generation in this business.

As I mentioned so far this year we’ve worked to implement and we’ve benefited from a number of key changes in the underlying drives of our business. These improvements worked together to create that positive feedback loop that I mentioned. Better network performance and customer support drive lower churn which results in a more tenure base of customers who call us last, demand fewer refunds and discounts.

As a result today we increased our adjusted EBITDA guidance by about $10 million. $2 million comes from our consumer cost structure and another $2 million is driven by sales traction and improved churn in our business segment at New Edge. The majority of the change $6 million relates to consumer revenue from better churn performance in the increasing tenure of our customer base.

To put this into perspective 92% of our premium dial-up customers have now been with us for 2 years or more. Additionally 30% of our premium dial-up customers have been with us 10 years or more; up from 17% a year ago.

For our people PC dial-up product and our broadband product we see the same trends. The customer base is ageing and as a result we have a better mix of customers with more tenure and therefore less propensity to churn.

We expected the continued ageing of our customer base to reduce churn this year, that’s no surprise. However what we did not expect and are pleased to see again this quarter is the improvement in churn within individual tenure cohorts. As a result of the conversion to these two factors we reported total churn of 2.9% this quarter. Down from 3.1% in the first quarter and down from 3.6% a year ago.

While we are not able to predict with certainty whether the customer behavior within cohorts will continue to improve or flatten out or return to prior levels, we do expect the churn rates will continue to benefit as the base continues to become more tenured.

Also contributing to the overall performance in consumer revenue is our value added services. We delivered $15 million in value added service revenue in the second quarter and now expect to beat our April expectation for vast revenue by $1.5 million for the full year.

There are three main components of value added services and all showed sequential improvements from the first quarter.

The first is subscription products like security and antivirus products. The second is search revenue where we recorded RPM’s for our company at much higher levels. The last area is advertising where aggregate second quarter revenue was modestly higher than first quarter despite the declining customer set.

Again while we can’t predict with certainty that we can improve these trends even further we built today’s guidance around an expectation that these latest trends are the new base line.

Moving on to the second main area that contributed to our over performance in the second quarter let’s move on to our consumer cost structure.

Beyond just benefiting from higher subscriber volumes better churn performance and increased customer tenure we also possible impacted our cost structure from all of those areas. More tenure than satisfied customers cost us less in many different ways on a per subscriber basis we handled fewer calls, we award less refunds in credits and absorb less bad debt. In addition we’ve been able to reap the cost benefits of new technology roll-outs, product simplifications and improvements in customer support activities and processes.

As a result we now expect to reduce our cost structure by approximately $2 million more than we expected in April despite higher subscriber volumes.

Our improved cost structure outlook also reflects the thousand little things our employees do every day to drive coat out of the business. Some good examples can be found in our customer support area.

This quarter we launched an auto-fix application which enables customers to self diagnose and resolve problems without having to make a call into our call centers. As a result of continuous efforts to improve processes both internally and by our great partners we reduce repeat calls and cases to the lowest levels in 14 months and achieved the highest customer satisfaction results since 2008. All of this combined with increasing customer tenure help reduce our per subscriber customer support cost in the consumer business to 4.2% of revenue in the second quarter from 4.8% of revenue a quarter earlier and 6% a year earlier.

Speaking more broadly about cost structure when we restructured the business in mid 2007 we eliminated half of our access business employees and a vast majority of our discretionary marketing spent.

Since the first quarter of 2008 our total company operating expenses including sales and marketing are down an additional 54%. We put the right compensation structure and centers in place for our people to find those thousand little things to improve the business and remove cost. And I continue to be impressed by our people’s creativity and capability in improving our cost structure.

The last portion of our improved 2010 outlook relates to a $2 million improvement at New Edge. Last quarter we reported that we were beginning to see sales traction in that business for the first time in two years and the SMB market appears to be continuing on its slow recovery.

In the second quarter New Edge’s book sales grew 28% over the previous quarter including some very large customer wins. We put substantial effort into building a more robust product set and providing consistent network performance which helped improve customer at segment churn in the second quarter to 1.9% from 2.7% a year earlier. As a result we now expect New Edge to consume $2 million less cash than we previously expected.

I’d like to move on to another key point. While we’ll be opportunistic when can profitably add new customers we know that the EarthLink consumer access business will decline over time. Certainly we are pleased that adjusted EBITDA held essentially flat for two consecutive quarters, but as we discussed our results will continue to be lumpy.

If you recall in the fourth quarter of 2009 we recorded several onetime expenses including a legal settlement and employee severance. In the first quarter of this year we did not have any significant onetime expenses and in this quarter we reported a favorable adjustment to revenue which Brad will explain in more detail.

You should expect this lumpiness to continue, there will be quarters without severance as we’ve seen in the first half of this year. There will be other quarters where we will recognize severance.

We’ll have time and we are spending money to variablise portions of our cost structure such as data centers and proprietary IT systems. Conversely there will be quarters where we have completed one of these projects and enjoyed the run rate benefits.

While the first half of this year didn’t include significant onetime expenses and even included some onetime credits, we expect to incur low single digit millions in onetime expenses in the second half of this year.

I’ll just remind you we focus on providing full year results and don’t try to predict our business on a quarter to quarter basis.

We are pleased with the momentum of the business and I think for good reason. Our employees have executed so well over the past 12 quarters that I think sometimes it can appear our results are a sure thing which I can tell you they are not.

We’ll continue to take a disciplined approach to managing the various risks that are inherent in a business like this.

I’ll now turn the call over to Brad to take you through our operating and out financial results in more detail and then I’ll end with some concluding remarks. Brad.

Bradley A. Ferguson

Thanks, Rolla. During the second quarter we generated adjusted EBITDA of $57 million which was essentially flat compared to the first quarter of 2010 and represented a 17% decrease from the second quarter of 2009.

As Rolla mentioned the second quarter of 2010 included a onetime revenue adjustment that resulted from a reconciliation with a partner and favorably impacted this quarter’s results.

EarthLink’s net income during the second quarter of 2010 was $28 million or $0.26 per share compared to $27 million or $0.25 per share in the first of 2010 and $31 million or $0.29 per share in the second quarter of 2009.

As for the balance sheet we ended the quarter with $740 million of cash and marketable securities of $32 million from the first quarter of 2010.

During the quarter we paid $17 million of dividends, $4 million in interest on our convertible notes and $3 million for capital expenditures.

Also we now sold all remaining auction rates securities at per plus accrued interest and have no auction rates security exposure remaining.

From a tax perspective while we expect to record a non cash income tax provision of just under 40% for the year we continue to utilize our federal and state net operating loss carry forwards which will result in a 3% to 4% effective cash tax rate in 2010.

As announced last week our board of directors approved another $0.16 per share quarterly dividend which will be paid in September this year.

During the quarter we repurchased $850,000 of EarthLink shares and management has the authority from our board of directors to buy up to an additional $146 million of shares under our share repurchase program.

Now to discuss some of the operating results and metrics in more detail. In the second quarter we had total growth subscriber additions of 67,000 which was down from the 77,000 we added in the first quarter of 2010 and 120,000 in the prior year quarter.

The new customer mix remain relatively steady as consumer broadband ads accounted for approximately 55% of total gross ads in the second quarter of 2010 consistent with both the first quarter of 2010 and the prior year quarter.

Churn in the second quarter improved decreasing to 2.9% compared to 3.1% in the first quarter of 2010 and 3.6% in the second quarter of 2009. As Rolla mentioned we’ve seen continued improvements in our churn performance compared to historical trends in addition to the churn benefits of our increasingly tenured subscriber base. And seasonal impacts of what typically is a lower churn quarter.

Total subscriber losses fell to 109,000 this quarter down to from 118,000 in the first quarter of 2010 and 149,000 in the second quarter of 2009. We expect that seasonal factors will continue to influence some of the quarter-over-quarter trends in the future. And to that point we expect the third quarter to have slightly higher seasonal churn than the second quarter of 2010. However consistent with our prior guidance historical trends suggest that both gross ads and churn should continue to generally decrease over time.

Total revenue for the quarter was $153 million, a 3% or $4 million decrease from the first quarter of 2010 and an 18% decrease from the second quarter of the prior year. As mentioned earlier the second quarter included a $2 million favorable revenue item that is non-recurring and therefore we expect that quarterly sequential revenue declines will increase in Q3, approaching the high single digit million dollars before they resume the attenuation we have seen and described in the recent past.

Our business services segment revenues declined 14% from the prior year second quarter as we saw pressures on the top line throughout 2009. However the declines have abated in the first half of 2010 as we are beginning to see the benefits of the positive sales traction and better churn performance at New Edge.

Our total cost of revenues declined 5% or $3 million compared to the first quarter of 2010 and 16% from the prior year second quarter.

We had a gross margin rate of 62% in the second quarter of 2010 compared to 61% in the first quarter of 2010 and 63% in the prior year second quarter.

Generally gross margin rates should continue to move slightly downward over time as they did from the prior year second quarter. Due to the continuing shift in the mix of our customer base to broadband and business segment services which have lower gross margin rates. However we had a favorable impact to the onetime revenue adjustment in second quarter which caused the slight uptake compared to the first quarter of 2010 in gross margin rates.

Operating expenses which include customer support, operations, G&A and bad debt expenses, but exclude sales and marketing expenses were $32 million for the second quarter of 2010, down $2 million from the first quarter of 2010 and down 22% from the second quarter of 2009.

As we have described decreases are primarily driven by fewer and longer tenured subscribers coupled with a thousand little things our employees have done to take out costs from the business.

Sales and marketing costs were $12 million in the quarter which was up slightly from the first quarter of 2010 and down 20% from the prior year second quarter due to lower discretionary marketing spend and sales and marketing employee cost in 2010.

As we have discusses in the past we continue to invest modest levels of marketing dollars in programs and channels within our consumer and business segments that provide a sufficient financial return.

Now for the updated outlook for 2010, as Rolla said earlier the second quarter continued to exceed our expectations at the underlying drivers of our business outperform historical trends. Factoring in this performance and assuming we can continue to deliver at these trends we are increasing our guidance for 2010 adjusted EBITDA in free cash flow.

In addition to increasing the guidance we are narrowing the range in both the adjusted EBITDA and capital expenditure projections. For 2010 we are increasing our previous adjusted EBITDA guidance of $194 million to $202 million and we now expect to generate full year adjusted EBITDA $205 million to $211 million. We are also maintaining the low end of the expected capital expenditures of $10 million and decreasing the top end of the reins to $14 million which is down from the $16 million in our previously issued guidance.

The $205 million to $211 million of EBITDA and $10 million to $14 million of capital expenditures translates into a projected $191 million to $201 million of free cash flow for the total year 2010.

This guidance reflects the continuation of the favorable trends we experienced in the first half of 2010. The continuation of our marketing spend and profitable channels such as cable broadband; a moderate decline in total gross ads from Q2 levels and the expectation that consumer churn rates will remain stable by cohort and reasonably predictable through the year.

Over the long term we still expect a gradual decline in adjusted EBITDA margins from Q2 levels, but for the business to remain profitable for years to come. Also I just want to reiterate that the first half of 2010 we had some favorable items such as the revenue item I referenced earlier and no significant expenses for items such as employee severance or other project related costs. As we said these costs will continue to make our earning lumpy in the second half of this year and beyond.

I’d now like to turn the call back over to Rolla for some concluding remarks.

Rolla P. Huff

Thanks, Brad. I’ll close the call by spending just a few minutes discussing how we are thinking about EarthLink strategic options beginning with New Edge.

While I mentioned the positive sales traction we are gaining at New Edge that business clearly continues to be under scaled. We are confident that New Edge’s continued momentum in product, sales and churn provides us with a proportionally better strength and optionality in considering all strategic alternatives for New Edge.

I think the strength of our company’s balance sheet as I mentioned before provides EarthLink as a whole with significant optionality and flexibility.

I hope that you’ll agree that we’ve proven to run our subscription business very efficiently. Given our execution and the value of our balance sheet we believe there may be opportunities out there in the ISP, [Sea Lark] and other related spaces where we could create shareholder value and so we will continue to evaluate and pursue these opportunities.

With that operator I’d like to open up the line for questions.

Question-and-Answer session

Operator

At this time if you’d like to ask a question (operator instructions). Your first question comes from Ingrid Chung with Goldman Sachs.

Ingrid Chung – Goldman Sachs

Thank you, good morning. So Rolla just to follow up on your remarks that you just ended the call with, I was wondering if you could do us an update on your New Edge plan. Last quarter you said that evaluations had improved making it more difficult to purchase assets. Has that view changed especially given the better performance there? And then secondly I was wondering according to our math it looks like broadband ARPU increased 5% quarter and quarter and actually increased 0.4% year-on-year which I think is the first increase we’ve seen in 5 or 6 quarters. Why did we see the broadband ARPU in the quarter?

Rolla P. Huff

Sure, let me just speak quickly to New Edge and then I think Brad can address the broadband ARPU. So I think that the New Edge evaluation has improved just because we see the momentum and New Edge starting to turn positive. As you know we’ve had a year of very difficult industry very difficult economy for businesses like New Edge. We are starting to see momentum there so we think that whatever we decide to do with New Edge whether or not we are seller in a space or we are a buyer in a space we believe that a stronger New Edge helps the business case whichever we are looking at. I think valuations overall in the industry have remained flattish to even down, I think since we last talked the market’s down roughly 6% so I think the valuations in that industry are down in roughly the same magnitude maybe even a little bit more, but the comment about New Edge evaluation is really driven by a positive momentum that we are seeing in that business. Brad you want to just quickly -.

Bradley A. Ferguson

Yeah, Ingrid I pointed out in my part of the script that we did have a onetime revenue adjustment that impacted the broadband ARPU. So that was a little over $2 million, I think if you take out you’ll see that the total consumer ARPU consistent with what you’ve seen over the last several quarters.

Ingrid Chung – Goldman Sachs

Okay, great, thank you.

Operator

The next question comes from Youusef Squali with Jefferies.

Youusef Squali – Jefferies & Co

Thank you very much, good morning, two questions please. Starting with Brad so if I look at the numbers and even adjusting for $2 million you just talked about, you went from doing $14 to $15 million revenue contraction quarter-on-quarter in the first half of year to now doing $6 to $7 million delta. So the first part of that question is this a reasonable run rate between now and a year and in other words are you seeing that would make that accelerate. Didn’t seem like that from your comments, but I’d like you to just confirm that.

Bradley A. Ferguson

Yeah, so factoring in the adjustment right, so that’s going to cause the decrease to be a little steeper going from Q2 to Q3, but neutralizing for the $2 million plus adjustment, it’s consistent with what you’ve been seeing.

Youusef Squali – Jefferies & Co

Okay, great so on that then guidance seems unduly conservative to us so even at the high end of your range it assumes margin compressions of several hundred basis or something like 300 to 400 basis points. Is there any reason for that?

Bradley A. Ferguson

Yeah, so what we talked about are just the unusual costs, I mean we’ll have things like severance which we’ve had in the past and expect to have some of that in the back half of the year. And then with some of our projects on the long range evolution as we are taking costs out of business we’ll incur some costs on the front end to get those benefits over the long term. So those are the type of things you’ll see in the back of the year again which will cause some lumpiness in the results that we talked about.

Rolla P. Huff

Yeah Youssef just to reiterate we really don’t try to manage the business on a quarterly basis, we try to manage it in blocks of really 12 to 18 months. So as we finish projects and we are able to take our cost structure down we do it and so you never hear us talk about taking special charges it’s just the way we run our business, but there is no question that severance will hit in one quarter and we won’t have as much exposure to it in the next quarter, but our guidance sort of reflects a broader plan that doesn’t include severance, we just don’t try to calenderize it for people.

Youssef Squali – Jefferies & Co

Okay, and then on the broadband side it seems like you guys picked up your ad spend, we’ve been seeing a lot more ads on the [Termua] [Phonetic] [0:28:23] cable, channel like CNBC etcetera. Is that a change in what you’ve been doing say in the last couple of quarters?

Bradley A. Ferguson

Well we are always happy to invest in marketing where we believe we are getting a return and there is no question that the cable the affiliate channel has been a strong channel for us, so we will and we have been and will continue to look for opportunities to invest in that channel because we think they are great revenue streams that create value for us.

Youusef Squali – Jefferies & Co

Okay, so but it’s not a change of – you are becoming you are not getting more aggressive with broadband ads for whatever reason because of the newly refund relationship with the Time Warner folks or anything.

Bradley A. Ferguson

No, we really ruin it by the numbers frankly where we believe we have momentum we’ll invest more into the momentum, but when you get right down to it Youusef we are talking about fairly small dollars on a total level.

Youusef Squali – Jefferies & Co

Good, okay, thank you.

Operator

Your next question comes from Scott Kessler with Standard and Poor’s Equity.

Scott Kessler – Standard and Poor’s Equity

Thanks a lot, so well my question is focused on essentially the last comments that you made about uses of cash. I think it’s pretty obvious that to some extent there may be a growing impatient in that the company may have a longer term horizons from some of these activities. The highlighted say fly back activity but really there wasn’t much to speak of in the second quarter and I’m just wondering, what kind of time table we might expect to see in terms of decisions related to ISP consolidation or acquisition in ancillary or related areas? Cause it seems to me like this is something that’s been talked about for years at this point and I think people are wondering when and if some of the things may happen. Thanks a lot.

Rolla P. Huff

Sure, well Scott I would say that…I literally…I don’t think that we’ve gotten the first call on the last 12 months about a lack of patience so that’s a…that’s a new one. You might have that view but I can just tell you we don’t get those calls and I until I get that would be the first point. I think what we hear and we try to check in with our investors on a fairly regular basis as we will today in meetings, is they want us to continue to be disciplined in our approach in terms of how we think about what would create value and what wouldn’t. So I guess that’s the first point; there is no question that we’ve been talking about uses of our cash over the last two or three years. I think one of the things that has been a challenge for us and I think you would probably agree with it is that the broader market has not been a picture of stability. And what we’ve talked about is that as the markets are stronger there is no question that the relative value of our balance sheet goes down; and so if you look at the last several quarters, as the market got stronger we were introducing dividends and we put a high yield on the share price that retained a little bit of optionality for us but started to return cash. But the market has been extraordinarily volatile and…and so our options sort of increase and decrease with the volatility of the market, but I think we have had a program over the last three years of looking for ways to return cash. I think in the last three years we’ve bought something like 20% of the outstanding shares of the company, we’ve initiated a dividend that has a pretty high yield, we increased the dividend last quarter, we took the opportunity when we had the opportunity this past quarter to buy some shares but we were limited by…we tried to be thoroughly conservative and so as soon as we saw that the quarter was going to come in above guidance we took the position that we should not be buying shares with that knowledge. So that’s how we’re looking at it. I just don’t feel like we are on a timetable, we’re trying to do the right things for the business. We manage the business I think in a very conservative way; there is no cash leaking out of the business, so we are going to continue to be flexible and disciplined in our approach, I can tell you that at board level we review with outside advisors this question of how best to manage our capital every single quarter so…it's the way I’d respond.

Operator

Your next question comes from Sri Anantha with Oppenheimer.

Sri Anantha - Oppenheimer & Co.

Yeah, good morning and thank you. Rolla just on the strategic front, I know you’ve made a comment that we may come off this decision from cost front with a long-term view but, without visibility on the revenue front for some reason or the other those cost initiatives that you have taken look somewhat shorter term. And secondly when you look at the M&A environment clearly the valuations have gone up and based on your prior comments you are…you seem to indicate that if valuations don’t come down there is a less likely often acquisition or M&A equity happening with EarthLink, is that still the case?

Rolla P. Huff

Well I guess I’m a little bit confused around the comment that equity valuations have come up. That…I think in the last 90 days since we last talked to you the markets are down about 6% and actually have been down well more than that just in the last 30 days.

Sri Anantha - Oppenheimer & Co.

Not within the 30 days or 90 days Rolla, we’re talking about a year ago when you all said, “Hey we have a higher optionality for our cash, the tax evaluations where we are, we can make a decree to acquisitions,” but clearly that’s no the case today.

Rolla P. Huff

You based that on what? Because we haven’t made an acquisition in the last 12 months.

Sri Anantha - Oppenheimer & Co.

No, no I’m just talking about it in general, see like acquisitions, hosting company acquisitions, the multiples have gone up compared to a year ago, wouldn’t you agree?

Rolla P. Huff

In some parts of the spaces they have gone up and in some parts of the space they’ve actually come down in terms of EBITDA multiples; it's different from situation to situation. So what…the way we think about this is how do we create value in a combination? And if we can create a lot of value and pay five and a half times, that doesn’t bother us at all if we think there is little synergy, we don’t want to pay three times because of the way we are valued. So we don’t think about valuation multiples on an output basis, we think about, as we look at alternatives, we look at how we believe we can create value in the combination with how we run businesses and the assets that we have to put with it. So that’s how we think of it.

Sri Anantha - Oppenheimer & Co.

Got it, okay…

Rolla P. Huff

I’m not sure…I’m not sure that I understood the first part of your question about cost visibility longer-term, I’m not sure…

Sri Anantha - Oppenheimer & Co.

I’m not talking about cost visibility longer term like…you’ve undertaken a number of cost initiatives, clearly they have helped the profitability and you guys have been steadily raising EBITDA for the past year or so, but we’re still seeing revenue declines around 15%+. Clearly that has moderated; what I’m asking is…unless we see some clarity where we can see the revenue growth or back to essentially where it’s going to be flat, some of these cost initiatives seem somewhat shorter-term in nature.

Rolla P. Huff

Gosh, I…first of all just to re-clarify, we don’t see the business that we have right now as a growth business. We just don’t see that that’s going to happen. I think that the ISP business is just…that is not where this business is and I don’t think that we’ve ever suggested that it will be. We have been working to stay out in front of the cost structure so that we know we get to the cost points before our revenue needs for them to get there to the extent that we’ve been beating our numbers over the last several quarters. The reasons have generally been centered around getting to the cost structure points sooner than where the model said we would be able to get them to. This last quarter was a little bit different in that we actually saw better strengths on the revenue side not because we were growing revenue but because the churn by cohort has actually started to improve over the last five or six months and that’s something that, based on historical trend lines, is very unusual for this business. So we’ve actually seen a little bit of help on the revenue on the top line from the churn on by cohort level as well as a little bit more momentum in the New Edge business. So I think the things that we do in terms of cost structure absolutely are long-term. I think we’ve shared with you in the past; we…today we have two data centers. I can tell you 24 months from now we will not; we’re worker hard longer-term projects to stay out in front of the cost curve so there’s still a lot to be done there. We know from just talking with smaller ISPs that have 200,000 subscribers that they’re highly profitable; today, they’re highly profitable at 200,000 subscribers. So it really boils down to keeping our cost structure in line as we manage the tail of this business and we really believe that’s where the value of this business is; it's in the tail.

Sri Anantha - Oppenheimer & Co.

Got it, okay thanks.

Rolla P. Huff

Sure.

Operator

Your next question comes from Mike Crawford with B. Riley and Company.

Mike Crawford - B. Riley & Company Inc.

Thank you, just…first a clarification; the ARS put right you had in June you said that those are now off your balance sheet, you got paid cash plus accrued interest, but did that cash come in after June 30th?

Rolla P. Huff

Yeah so that’s all reflected as cash in our 6.30 balance sheet; we actually…some of the…we actually settled that on the 1st but in our reported earnings…July 1st, but in our reported cash number it's in there. So no put rights for those are fully valued.

Mike Crawford - B. Riley & Company Inc.

Okay, great. And then rather than…well, at the risk of beating a horse to death, on New Edge, when I hear Rolla, your language you talk about exploring alternatives but from the perspective of the way you talk about it the, the right seems to me like one EarthLink acquring someone to see what you would want to put in and what synergies you would get as opposed to you selling New Edge to someone else and seeing what synergies they would do with the business; is that…am I not reading that correctly?

Rolla P. Huff

I think that…I think that we’ve been clear that we’re willing to be a buyer or seller in the space as the markets get…have gotten stronger we probably leaned in to the seller side because the markets were getting stronger. As the markets get weaker we have more opportunities on the buy side, so it really does…how we look at our alternative is really being driven by what’s happening in the markets and the markets have been extraordinarily volatile from quarter to quarter and I think just overall we’ve spent a lot of time and energy getting our company to a place where we actually have alternatives. And we’re trying to be thoughtful and we’re not going to be in a hurry to jump to a conclusion one way or the other. And while we’re going through the process we’ve started and continued the return of cash where we think it makes sense.

Mike Crawford - B. Riley & Company Inc.

Okay, thank you.

Rolla P. Huff

Sure.

Operator

Your next question comes from Rick D'Auteuil with Columbia Management.

Rick D'Auteuil - Columbia Management

Yeah, again I know we talked about beating a dead horse but the cash…you said that the directors of the board continues to look at the different options, would the tax law changes likely to be an incremental negative as we go on to the new year. We are seeing a lot of our companies distribute some of their excess cash or talk about distributing their excess cash before year end, how is that being considered by the board here?

Rolla P. Huff

Sure, yeah we’ve had a lot of discussion about it actually. I think that it's important to know we’ve especially been conscious of what it looks like. Dividends, tax rates are going to do well, it hasn’t been finalized yet the push as we feel it and listen to it is that tax rates on dividends are going to go up fairly substantially. If you look at…if we get a special dividend tomorrow; the vast majority of the special dividend would wind up being a return of capital as opposed to a dividend. We think that if…just hypothetically if we announce the special dividend tomorrow or we announce the special dividend in June of next year of $100 million, roughly $20 million of the return would be seen as a dividend with the rest being a return of capital. So we have thought about that a fair amount and that’s part of the calculus that I think our board goes through on a regular basis and understanding the impacts of the various timing scenarios that we might think about thus.

Rick D'Auteuil - Columbia Management

So what…I know I think I know about the answer, I’m just curious about a direct response but what is your yield on your cash right now?

Rolla P. Huff

The nominal.

Bradley A. Ferguson

30 basis points.

Rolla P. Huff

Sure.

Rick D'Auteuil - Columbia Management

Sure. Okay, so one of the earlier questioners made reference to back in late ‘08, early ‘09 I think you came to share holders and you said give us a little more time to deploy the cash; we are seeing some good opportunities out there and for whatever reason, nothing was executed during that window of the depressed valuations and if you weren’t buying then, I would think you’re not exactly champing at the bid at today’s valuation but as you mentioned before, you might be seeing some things that are still attractive. At some point it probably does make sense and we’ve been long term patient, we think we’ve applauded all of your moves to date and -- I’m with Columbia management which is now part of Ameriprise, but we probably show up still under Bank of America as a holder some one of your larger holders, just maybe it does make sense -- the sort of wave the flag and say some of this ought to be pushed back the shareholders in some fashion. I just throw it out there, I know it’s being considered but 0.3% is a pretty atrocious return and it’s -- at some point I think we’ve been better -- we’ve been more rewarded with return of capital be they buy backs or some sort of return of capital dividend.

Rolla P. Huff

I appreciate the comments. As I said, we -- and I think you’re actually one of the folks that we’ve talked to in the last six months or so and I don’t think that we’ve gotten a lot of the feedback around its time. I think if we’d look at it over the last couple of years, I think we have provided a great return for our shareholders against the market so I am not quite sure that if I was sitting in your seat I would be looking at the return rates on the cash. I think I’d be looking against our performance against the market both at an equity level and what our yield has been and the feedback that we’ve gotten has been pretty strong. But just rest assured that we look constantly about the implications of what a quick return of cash would be and we weigh the risks of that against the other alternatives we have and that’s something that receives a lot discussion.

Rick D'Auteuil - Columbia Management

Okay, just -- again, I wanted to -- as a long term not journey completely shareholder just got to throw it out there, a little disappointed in the buy back. I don’t know if you guys are more conservative than other companies on what -- what your window is to buy shares but a little disappointed in the deployment on that front. But I think you explained that and felt like you needed to close window with knowing the quarter was going to come in better than expected.

Rolla P. Huff

Clearly, we get limited by what we know about the business that isn’t public and literally between dialogs that we have with people that require us not to be in the marketplace and what we know about what is happening with the business is not in the marketplace. We are conservative that way.

Rick D'Auteuil - Columbia Management

Okay, thank you.

Rolla P. Huff

Sure.

Operator

Your last question comes from James Cakmak with Sidoti

James Cakmak - Sidoti

Hi, good morning,

Bradley A. Ferguson

Morning

James Cakmak - Sidoti

Just to better gauge the opportunities on the cost side, historically you guys have said that about half of your G&A costs are variable in about 2/3 a year customer service cost are; where would that be today?

Bradley A. Ferguson

Well today overall we’re I think the latest number at the end of the second quarter we were about 67% of our cost structure was variable and with obviously the balance being somewhat fixed, but we continue to take core structure out at both variable core structure in terms of better processors where we’re taking out variable costs at a higher rate than what subscribers are doing and then in terms of fixed cost structure, I think we’ve been very successful at taking out the fixed cost infrastructure at faster rates so right now it’s about a 67-33 split variable to fixed.

James Cakmak - Sidoti

Okay, and have you guys seen any improvement in return rates associated with your broadband customers?

Bradley A. Ferguson

It’s seen modest improvement on cohort basis but I think if you look at the information that we’ve made public, we see fairly low churn rates on tenured broadband customers, well under 2%.

Rolla P. Huff

Yeah, total DSL churns at 1.9 this quarter and it’s been at that level for a while and tabled a little higher now just over 3% but that’s really with the edge of the base -- much younger given the add activity that we’ve had in the recent past.

James Cakmak - Sidoti

And you guys do you see more opportunities to create more whole marketing agreements with the cable providers or tackling other regions?

Rolla P. Huff

Well, we are looking for more opportunities. We did a public filing on our view of the ComCast NBC Universal merger that if the FCC and Comcast agree would have the potential of opening up more cable markets to it so we clearly are looking at those as opportunities.

In terms of the Time Warner footprint, there have not been new markets that have opened up in the last four quarters.

At this time last year, they were opening up a couple of new markets. They came out of the Delphi split up so that had represented a great opportunity for us to actually penetrate new markets.

James Cakmak - Sidoti

Okay, and lastly, you guys have a certain amount of NOL. I guess how does that factor into the picture when you think about your strategic option?

Rolla P. Huff

Well, we think that it allows our extraordinary valuable and we -- the real cash from our standpoint so we pay close attention to that.

James Cakmak - Sidoti

You mean the fact that they’re probably going to be running out within the next two years.

Rolla P. Huff

We’ll -- most of the NOLs probably in some time in 2012, I think, the way the run rates looks.

Bradley A. Ferguson

We have some that are limited based on historical acquisitions that we use over time but the majority will be used up.

Rolla P. Huff

Right, and so as we think about -- we don’t want to do anything that would limit the NOLs that we have and clearly because this is a cash producing business, an income producing business, the idea of acquiring NOLs are certainly part of equation as we look at doing anything.

James Cakmak - Sidoti

Okay, thanks a lot.

Bradley A. Ferguson

Sure.

Operator.

There are no further questions at this time.

Rolla P. Huff

I’d like to thank everybody for joining us on today’s call, we’ll be out visiting with many of the people on this call here over the next day or so, so I appreciate your attention and we’ll look forward talking to you again in 90 days.

Take care.

Operator

This concludes today’s conference call, you may now disconnect.

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