EarthLink Q4 2006 Earnings Call Transcript

TRANSCRIPT SPONSOR

EarthLink, Inc. (ELNK)
Q4 2006 Earnings Call
February 6, 2007 8:30 am ET

Executives

Kevin M. Dotts - Chief Financial Officer, Executive Vice President
Michael C. Lunsford - Interim Chief Executive Officer
Mike Gallentine - Vice President, Investor Relations

Analysts

Youssef Squali - Jefferies & Co.
Anthony Noto - Goldman Sachs
Heath Terry - Credit Suisse
Bryan Goldberg - Bear Stearns
Chris Rowen - SunTrust Robinson Humphrey
Jim Friedland - SG Cowen & Co.

Presentation

Operator

Good morning. My name is Jocelyn and I will be your conference operator today. At this time, I would like to welcome everyone to EarthLink's fourth quarter 2006 earnings conference call. All lines have been placed on mute to prevent any background noise. After the speaker’s remarks, there will be a question-and-answer session. (Operator Instructions)

Thank you. Mr. Kevin Dotts, CFO EarthLink, you may begin your conference.

Kevin M. Dotts

Thanks, and welcome, everyone, to our call. This morning I am joined by EarthLink's interim CEO, Mike Lunsford; and our Vice President of Investor Relations, Mike Gallentine, to discuss our fourth 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 risks 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 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 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 to the SEC, both of which are available on our website at www.earthlink.net.

Now, let me turn things over to Mike.

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Michael C. Lunsford

Thanks, Kevin. I would also like to welcome everyone to the call. Before I address our results for the quarter and year, I would like to make a brief comment on our previously announced CEO search. As we announced earlier, after the passing of Garry Betty, the EarthLink Board has appointed me as interim CEO. We are in the process of conducting a search for the permanent replacement at this time, and we have contracted with an internationally recognized firm to conduct that search.

As well as looking externally, the Board has asked me, and I have agreed, to be a candidate for the permanent CEO role. Until such a time that a permanent appointment is made, I will be leading the company’s day-to-day operations and joining you for these calls.

In the fourth quarter of 2006, we continued to execute on our strategy to become a total communications provider by investing in and growing our broadband initiatives and voice municipal WiFi and HELIO. At the same time, we continued to generate significant profits from our narrow band services and search advertising and value-added services businesses. This was also the first quarter in EarthLink's history where revenue from broadband services was higher than narrow band.

Before turning the call back over to Kevin for the review of our financials, I would like to summarize our progress across our new broadband initiatives in voice, municipal WiFi, and HELIO. I will close out my portion with a comment on our core services and value-added services.

First, our new broadband voice services business. We launched voice services in eight additional markets late in the third quarter and by the end of the fourth quarter, we were deployed in 12 markets, representing over 10 million homes passed. Our partner, Covad, continued to fill in coverage in our new markets during the quarter as we focused on customer demand creation and on streamlining our provisioning process.

I am happy to report that we had our best quarter yet for new voice subscribers, with 12,000 net new subscribers. As we move into 2007, we continue to target an incremental 0.1% penetration per month in the markets served.

We feel we have a very compelling voice offer. Unlimited local and long distance calling from the existing handsets in the home, coupled with fast 8-megabyte DSL service for less than $70 per month is a significantly better value than what is being offered by the traditional telephone and cable companies today.

Let’s turn to municipal WiFi. During the fourth quarter, WiFi continued to gain momentum, both as a new way to connect to the Internet but also as the lowest cost way to blanket cities with inexpensive wireless broadband. We are still in the early stages of deployment but we are seeing increasing demand from local governments, as EarthLink has become the acknowledged market leader in this space.

Underscoring our early progress, we were awarded the right to build a municipal WiFi network for the City of Alexandria, Virginia; we launched service in both New Orleans and Milpitas, California; we launched the first phase of our new network in Philadelphia in January; we reached a final contract with the City of San Francisco, to be approved by the Board of Supervisors, to build the city’s municipal WiFi network; we were selected by the City of Atlanta to build, own and operate a municipal WiFi network in that city; and we have reached an agreement with Vonage to provide wholesale access to our municipal WiFi network.

As we move forward in 2007, we expect to complete municipal WiFi networks in these cities and we will continue to pursue additional arrangements with other cities to further expand our municipal WiFi footprint.

By the end of the first quarter, we expect to have over 250,000 addressable households covered and we are targeting over 1.5 million addressable households to be covered by the end of 2007.

These city network agreements and the municipal WiFi networks that we will own are a unique asset for EarthLink. Never before has there been a possibility to provide low-cost, city-wide ubiquitous high-speed network access like this. The true power and value of these networks cannot yet be fully determined, but once these networks are deployed, it will spur the creation of products and services that we cannot even imagine today.

Now I would like to talk about our progress at HELIO, our joint venture with SK Telecom. The HELIO brand launched in May, 2006, and the company began marketing in mid-July. The fourth quarter was HELIO’s first quarter of significant ramp-up. HELIO ended the quarter with approximately 70,000 subscribers. These subscribers are high-octave and are all post-paid, which is an important distinction from most other MVNOs in the U.S. HELIO expects to pass 100,000 subscribers early in the second quarter, less than 10 months from its launch of active marketing.

Our partnership with SK Telecom gives HELIO access to some of the most advanced wireless technology in the world and HELIO is using that to its advantage. Since launch, HELIO has: put three high-end exclusive handsets into market; launched the first MySpace mobile service; launched the first-ever buddy finder service by a carrier; and launched the first GPS-enabled Google Maps.

In addition, HELIO’s advertising and buzz marketing have been effective in carving out a niche with its target consumers, already achieving approximately 60% aided awareness with its young consumer core segment, and 70% aided awareness amongst Korean-Americans for its HELIO powered by SK Telecom brand.

HELIO has also successfully grown its distribution channel from zero to about 2700 retailer doors nationwide, and in the fourth quarter, opened its first four HELIO company-owned stores in Santa Monica, San Diego, Palo Alto, and Cherry Creek outside of Denver.

Kevin will share some additional financial information in a moment, but EarthLink is encouraged by HELIO’s ramp-up, its differentiation, and the high ARPU characteristics of its subscriber base.

Now I would like to cover our search, advertising and subscription-based value-added services, or VAS business, in our core access services, which continue to generate significant cash flow for investments in the new broadband growth initiatives I just discussed.

For the past several years, value-added services has been a significant driver of value for EarthLink. In a moment, Kevin will discuss the financial impact related to our value-added services, but I would like to share some of the items that have helped generate our growth in VAS revenue.

Our subscription-based products were led by a 40% increase in security-related product revenue quarter over quarter. We expect our subscription-based revenues to continue to grow at double-digit rates, driven by our expanded security offering, which includes EarthLink's own protection control center.

Advertising revenue grew 12% quarter over quarter, driven by an increased depth of user engagement, as demonstrated by a 12% increase in impressions. Compared to the fourth quarter of 2005, advertising revenue grew by 65%, with impressions increasing over 30%.

Search revenue increased 6% quarter over quarter, driven by higher RPOs. Compared to the fourth quarter of 2005, search revenue was 20%, also driven on higher RPOs. We expect the revenue growth trend to continue through 2007 with double-digit growth in RPOs.

For our core access services, the trends that EarthLink and the Internet market experienced over the past several years continued in the fourth quarter. These trends include growth in broadband and value narrow band, coupled with declines in mature premium narrow band services. During the fourth quarter, EarthLink achieved 29,000 broadband net subscriber additions, which includes a one-time negative 19,000 subscriber adjustment related to a broadband partner’s database reconciliation. Additionally included in the net subscriber additions are the 12,000 net voice subscriber additions I mentioned earlier.

Narrow band declined by 29,000 net subscribers during the quarter, which includes 76,000 net People PC value subscriber additions. EarthLink finished the year with 3.3 million narrow band subscribers, of which 1.5 million are People PC branded subscribers.

However, as we expected, as the premium narrow band base has matured, we have seen a significant decrease in customer churn. In the fourth quarter, average premium narrow band monthly churn was only 4.4%. This is a level that we have note experienced since 2002.

This quarter, EarthLink made significant strides in further transforming into a total communications provider. We won new municipal WiFi networks, launched our expanded service in markets, and signed on new wholesale partner agreements. In voice, we continued marketing the most compelling voice data bundle on the market and had our best quarter of growth year-to-date.

HELIO ended the year on $100 million revenue run-rate, and expects to surpass the 100,000 customer mark early in the second quarter of 2007. We continue to grow value narrow band and broadband while effectively managing the premium narrow band decline.

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

Kevin M. Dotts

Thanks, Mike. In the fourth quarter of 2006, our core Internet access services continued to generate consistent amounts of EBITDA and free cash flow compared to 2005. We continued to reinvest this EBITDA and free cash flow into our various growth initiatives to generate revenue and earnings growth in future periods.

The impact of our strategic growth initiatives is reflected in the current quarter increase in broadband revenues, which were $115 million, a 35% increase compared to the fourth quarter of 2005. The revenue growth was primarily due to the addition of broadband business services and broadband voice services.

Our other area of growth this quarter, as well as the previous 14 quarters, was advertising and other value-added services, which increased to $24 million, or 25% growth compared to the fourth quarter of 2005.

This revenue growth was due primarily to an increase in search, advertising, and subscription-based value-added service revenues. Together, these services generated a record $1.52 per subscriber in incremental ARPU per month compared to $1.21 during the fourth quarter of 2005.

While we generated revenue growth in our strategic areas, our narrow band and web-hosting services continued to see revenue declines. For the fourth quarter, narrow band revenues were $145 million, a 16% decrease compared to the fourth quarter of 2005. The decrease in narrow band revenues was primarily due to the decline in premium narrow band subscribers partially offset by the subscriber growth in our value brand, People PC.

Overall, revenues for the quarter were $328 million, a 5% increase from the fourth quarter of last year, driven primarily by the growth in broadband revenues and advertising and other value-added services, partially offset by the decline in narrow band and web-hosting revenues.

In the fourth quarter, our core access services generated $58 million of adjusted EBITDA compared to $56 million in the same quarter of 2005. As we have deployed or expanded our internal strategic growth initiatives, we indicated these would be funded through cash flows from our current operations. As such, our operating expenses and sales and marketing efforts have increased. This in turn has reduced reported adjusted EBITDA to $22 million, or a 54% reduction from the fourth quarter of 2005.

Further impacting net income is our wireless initiative, HELIO. As HELIO has increased their initial ramp-up, our proportionate share of HELIO’s loss has increased to $36 million compared to $9 million in the fourth quarter of 2005. As such, coupled with the growth in operating and sales and marketing expenses, EarthLink generated a net loss of $25 million for the fourth quarter, compared to net income of $29 million in the fourth quarter of 2005.

HELIO generated $23 million of revenue in the fourth quarter, and after less than six months of active marketing, they have generated a total of $47 million in revenue in 2006, and ended with an annualized run-rate of over $100 million in revenue. We believe this represents one of the fastest ramps for a new wireless company.

HELIO subscriber ARPU was $100 at the end of 2006, well above industry averages. HELIO is still ramping up and has not yet developed the advantages of economies of scale and as a result, HELIO’s fixed cost and CPGA are above industry averages. In addition to its initial investments in infrastructure, HELIO’s CPGA costs are largely front-loaded with subscriber acquisitions, so fast growth translates into greater capital requirements during the ramp-up period. As a result, for the quarter and the full year, HELIO generated a net loss of $74 million and $192 million respectively. Our proportionate share of the loss for the quarter and the year was $36 million and $85 million respectively.

During the fourth quarter, we increased the amount of operating cash flow used to fund the various growth initiatives previously described. Additionally, we used $21 million for capital expenditures and cash payments for subscriber-based acquisitions in the quarter, compared to $9 million in the fourth quarter of 2005. As a result, we generated $1 million of free cash flow during the fourth quarter of 2006, down from the $38 million generated in the fourth quarter of last year.

Also during the quarter, the company repurchased 800,000 shares of EarthLink common stock, for a total of $6 million. Since the inception of our share repurchase program, we have acquired 62 million shares for $508 million.

Finally, during the quarter, we successfully issued convertible bonds which generated net proceeds of $237 million. At that time, we disclosed that these proceeds would be used for general corporate purposes and that they would include future investments in our various strategic growth initiatives or share repurchases.

We ended the fourth quarter of 2006 with $395 million of cash and marketable securities, a decrease of $27 million compared to the fourth quarter of 2005.

We are constantly analyzing the best use of our cash and the cash flow generated by our access services. Historically, we felt the best use of our free cash flow was primarily to repurchase company stock. In 2006, we primarily invested our free cash flow in our growth initiatives as they have developed. Although it is early, we are now seeing encouraging progress in these new initiatives and we are allocating our capital appropriately.

The Internet is in the midst of a major shift from wired narrow band to wired and wireless broadband. In order to grow our revenue, long-term profitability, and maximize our shareholder value, we will continue to prudently and methodically put EarthLink in position to participate in that transformation.

We will now provide our outlook for 2007.

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.

In 2007, we expect our growth initiatives to begin to contribute to net subscriber additions in a more meaningful way. However, as we are increasing our voice service marketing efforts and expanding our municipal WiFi coverage areas, we expect the contribution from these initiatives will have a greater impact in the second-half of 2007.

For our core access services, we expect limited growth in traditional broadband and value narrow band, coupled with continued subscriber declines on premium narrow band. Additionally, as we’ve previously announced in October, 2006, in the second quarter of 2007, upon the expiration of the Embark broadband wholesale agreement, we will remove approximately 750,000 to 775,000 low ARPU wholesale customers from our reported subscribers.

Accordingly, for the full year 2007, excluding the one-time Embark adjustment, the positive subscriber additions from our growth initiatives will be offset by declines in our premium narrow band services and we expect net losses of 75,000 to 175,000 subscribers.

We expect revenues to be $1.3 billion to $1.35 billion compared to 2006, as gains in municipal WiFi subscribers and higher ARPU broadband, voice, and business service subscribers from our growth initiatives, coupled with growth in search, advertising and incremental products, offset declines in premium subscribers.

We expect our core access services to generate $180 million to $200 million in adjusted EBITDA for 2007. As we will be marketing our expanded broadband service offerings for all of 2007 compared to only a partial year in 2006, we expect sales and marketing and operating expenses to increase in 2007. For the fully year 2007, we expect to generate adjusted EBITDA of $80 million to $100 million.

EarthLink's expected proportion share of HELIO loss will be $160 million to $180 million. Coupled with the reduced adjusted EBITDA, we expect a total EarthLink net loss of $110 million to $150 million. EarthLink expects HELIO to continue to aggressively grow their subscriber base during the year, more than tripling by the end of the year, with 200,000 to 250,000 subscribers. These are expected to continue to be high ARPU, post-paid subscribers in the $90 to $100 range.

For the year, EarthLink expects HELIO’s revenue will more than triple to $140 million to $170 million. Based on negotiated carrier network pricing in effect for 2007 and beyond, that should translate into a dollar gross margin nearly as high as the typical U.S. carrier’s total ARPU. This gives us an encouraging view of HELIO’s long-term profit potential.

Previously, HELIO made investments in back-office systems for billing, customer service, and content management and distribution that will allow it to scale to a large number of subscribers in the coming years. During 2007, we believe HELIO will continue to introduce new products and services and to expand distribution in retail channels and a limited number of company-owned stores. EarthLink believes that as HELIO continues to build their subscriber base, its cost structure will begin to realize the benefits of economies of scale, which should result in improved gross margins, lower CPGA, and better operating margins.

However, as HELIO will not have yet have realized the benefits of economies of scale and will be incurring increasing sales and marketing expenses as it ramps up throughout the year, EarthLink expects EarthLink will generate net losses of $330 million to $360 million in 2007.

EarthLink is pleased with HELIO’s early performance. After just six months of marketing, they have carved out a highly differentiated, high-end niche position, as evidenced by a high ARPU and average selling prices of their handsets well above industry averages, as well as the high usage of their services by their subscribers and rapidly growing brand recognition in their target markets. They have accomplished this through an innovative offering built with the help of SK Telecom technology, a number of industry-first services that Mike talked about earlier, combined with effective marketing and growing distribution.

For the full year 2007, if EarthLink included its proportionate share of HELIO’s results, approximately 50%, rather than expecting a subscriber decline, we would expect to be approximately flat for the year. Looking at revenue, we would expect revenue growth of $70 million to $120 million, or up to almost 10% yearly growth rate.

EarthLink and our partner, SK Telecom, continue to work together monitoring HELIO’s operating performance. Based on investments already made in building an infrastructure and establishing distribution channels, and noting early signs of success in growing this high ARPU subscriber base, EarthLink expects that HELIO will require additional investment in 2007 to support future growth. Although no decisions have been made at this time, we believe an additional investment by EarthLink could be warranted.

Now, coming back to the overall EarthLink picture, for the first quarter of 2007, we expect growth in broadband, value narrow band, search advertising and incremental products and limited positive impacts from our growth initiatives, offset by revenue declines from premium narrow band. Overall, we expect revenues of $325 million to $330 million.

We expect to incur a higher sales and marketing spend of approximately $5 million in the first quarter and one-time expenses of approximately $6 million related to the benefits due Garry Betty’s estate under his employment agreement. As such, we expect adjusted EBITDA of $7 million to $12 million.

Coupled with our proportionate share of HELIO’s loss, which is expected to be between $35 million and $40 million, we expect a net loss for the first quarter of $32 million to $42 million.

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

Michael C. Lunsford

Thanks, Kevin. I wanted to say on behalf of EarthLink, and as a friend of Garry’s, thanks to many of you for your thoughts, prayers, and finally sympathy and condolences on the news of Garry’s sickness and eventual passing. Garry was instrumental in building EarthLink into the company it is today. He leaves behind a tremendous record of achievement and an accomplished management team committed to pursuing our share vision of becoming a total communications company.

We accomplished a great deal in the fourth quarter and in all of 2006. We fully recognize we have a great deal yet to accomplish to fully implement our vision and to complete the transition of EarthLink into a total communications company. I am confident we have the people and partners in place to realize that vision and successfully execute upon it.

I will turn the call over to the Operator to open the line for questions, though I can’t possibly imagine there will be any.

Question-and-Answer Session

Operator

(Operator Instructions)

Your first question comes from Youssef Squali.

Youssef Squali - Jefferies & Co.

Good morning. I have a couple of questions. First, one on HELIO, how can I not? It looks like by the end of ’07, you will have contributed about $280 million to that JV, which is substantially higher than the $220 million you had committed to it at the outset. How much more investment do you expect you need to put in before it becomes self-funding? You guys had talked at last year’s analyst day about it becoming self-funding by the end of ’08. Is that still the case?

Second, can you just clarify how many broadband access subscribers did you add during the quarter, ex voice, ex new edge and normalized for the 19,000 subscriber correction?

Kevin M. Dotts

Let me cover the first one here and try to get you an answer on the broadband access. To be clear, our investment of cash in HELIO under our original commitment was $180 million.

Youssef Squali - Jefferies & Co.

I included the assets that you also infused in there.

Kevin M. Dotts

Yes, and the assets that were infused would have been 40, so that would have been a total 220.

Youssef Squali - Jefferies & Co.

Correct, yes.

Kevin M. Dotts

Okay, and so in total, we have no commitments at this time beyond that 220. Now, we recognize --

Youssef Squali - Jefferies & Co.

Just to clarify that, if I look at the investment, or the loss from the JV in ’05, it was about $15 million. In ’06, it is about $84 million, and you are guiding for $165 million to $180 million in ’07. That is how I am getting to my $280 million.

Kevin M. Dotts

Right, so you are deducting out that there could be as much as a need for $280 million, I understand that. Again, I just want to reinforce that we haven’t made any decisions, the Board hasn’t made any decisions at this point. We are very supportive of HELIO. We are very impressed by its very rapid growth that it demonstrated in the fourth quarter. With that, we suggest that EarthLink, speaking on behalf of EarthLink, we are contemplating -- but we have made no decisions -- an additional investment, which could be as much as $50 million to $100 million this year.

Now, that being said, to the second part of your question as to where they go free cash flow positive, we are not really updating guidance on the out years at this point in time, although through different modeling scenarios, we believe that they are still in plan to be at about a free cash flow positive scenario sometime in potentially in 2009.

Youssef Squali - Jefferies & Co.

Okay, and on the broadband access?

Kevin M. Dotts

Right, so we reported about 29,000. The adjustment impact that we reported was from a reconciliation performed within the Embark system, which we were paid for those subscribers but they were adjusted in the last couple of weeks of the quarter. If you back out that $19 million negative hit, it would have been about 48 million -- 48,000, excuse me. That would have been nice, to be 48 million. Backing out the voice element, that would have been about 12,000 net adds, so that brings you to 36, and we added 2,000 for new edge, which would have brought you at about 34,000 net broadband access subscribers.

Youssef Squali - Jefferies & Co.

Do you think that is a good steady net add number?

Kevin M. Dotts

I think when we are looking at broadband at this point, when we talk about our retail or consumer, ADSL and consumer, I think at this point, we anticipate, and we did say this in the script, that we think it is relatively flattening out at this point. What will grow though are the bundled services with voice through 2007, and then we will be introducing more of the WiFi, which again we said would be a greater participant in the second-half.

Michael C. Lunsford

Youssef, particularly on the bundled voice subscribers and straight DSL and cable subscribers, I think you will see a muddling of that marketing over time so that the acquisition costs will almost be shared across a number of different technologies. The consumer in the end will pick the one that is most appropriate to them, so to Kevin’s point, I think you will see higher growth of the bundle but the marketing of that will be mixed. It will be hard to pull apart.

Youssef Squali - Jefferies & Co.

Okay. Thank you very much.

Operator

Your next question comes from Anthony Noto.

Anthony Noto - Goldman Sachs

Thank you very much. I guess the first question I have is on HELIO. Obviously the core business has a much higher level of EBITDA than you are reporting, and it is due to the number of investments you have across all of your new businesses becoming a communication company.

I was wondering if you could talk specifically about WiFi and then separately about HELIO. What level of subscribers do you need to obtain to become profitable in each of those businesses? What would be the corresponding ARPU and then contribution margins of subscribers, ARPU, and contribution margin for WiFi and HELIO separately?

Then, one follow-up: given the unfortunate timing and loss of Garry, did the Board at any point contemplate potentially backing away from some of these investments and potentially trying to harvest the business and increase shareholder value by paying out more of a dividend strategy in terms of some of the declining telco companies? Thank you.

Michael C. Lunsford

Thanks, Anthony. I will take the last one first. As far as the Board, our management redirecting the strategy at this point, we think we have a good strategy. At all times, we look at each of these elements and put it through a fairly rigorous process of evaluating the microeconomics of each and every market, what HELIO is doing, how much we spend on voice, et cetera. We will consider each of those appropriately over time.

Right now, the strategy is holding and looks to be the right one, but again, we will always revisit those.

As far as HELIO, well, Kevin, there are some numbers there. Why don’t you respond to that and then I will come back.

Kevin M. Dotts

Right, so with regard to HELIO, I think as far as the break-even point, Anthony, if I understood your question correctly, we talked about the fact that currently they are about $100 of ARPU and we expect that to continue through 2007. We suggested that the gross margins currently are higher than the average ARPU for cellular providers. If you look at that, that would suggest, that is best on our go-forward arrangements for 2007 pricing with the carriers, our carrier partners. So those averages are let’s say in the $45 to $50 range. So we see a scenario where you continue to grow this product rapidly over the next couple of years, and that generates a tremendous amount of profit as it scales.

Again, to the earlier question we were asked, the timing of that, we expect that free cash flow to be positive relatively in the 2009 timeframe. We have not given a specific subscriber number as to when the whole business is free cash flow positive.

With regard to WiFi, jumping to that for a second, I think the way we are thinking about WiFi, and we talked about this, when we are retailing WiFi, think about an ARPU of about $20 and the contribution margins on those subscribers we think aspirationally are about $10, so they are kind of right now in the economics where DSL, between where a DSL subscriber is, a cable subscriber and a narrow band premium subscriber is, so they generate pretty good dollars. Your investment is obviously into the network and you are trying to figure out how you recover that network.

When we are looking at that, we are thinking about somewhere between $3 to $4 per household covered is what gets us to the range of when you actually are now on the total network free cash flow positive. So as an example, in Philadelphia, we are building out a network there that will cover about 600,000 to 610,000 households and by the point of about $3 to $4 of ARPU per household, then we would be free cash flow positive in that network.

Anthony Noto - Goldman Sachs

Thank you.

Operator

The next question comes from Heath Terry.

Heath Terry - Credit Suisse

Great, thank you. I was wondering if you could talk to us a little bit more about the municipal WiFi business, just some of the economics around the build-outs of these latest wins, as well as what kind of usage levels you are seeing, realizing that even your most mature markets are still very, very early stage, but if you can just talk to us about what kind of usage levels you are seeing there, and if there are any trends in terms of where those customers are coming from. Are they narrow band customers migrating up, broadband customers migrating over to municipal WiFi, or is there something else that you could talk to us about within that trend?

Michael C. Lunsford

I will take the usage question and then Kevin can answer the first part of that. It is still a little too early to tell. Frankly, some of these markets, the group of concept markets in Philadelphia are just launching now in January. All told, we are still in the low-thousands of customers, so it is hard to get really useful information for you.

What I can tell you is we are seeing, particularly when we light up a market and offer service for free, we are seeing a lot of investigative I would say sniffing around of network and usage there. We are seeing penetration rates in the first few months that track to what we had planned and then some in the markets that have been up longer, i.e. Anaheim.

Usage is across a number of devices, which we can tell from the networks, which surprise us a little bit. We are still seeing, and this is true across any of our nascent businesses and always has been, back to the days of broadband and really early on in dial-up, the early churn is higher than we would like it to be, and that is driven by customers who are on the fringes of the network and are unable to get a solid signal. They are counted as a sign-up and then as churn. But also by some customers who do not understand the product fully and what it will do for them. That will come down over time. We always see that, but it has been a little higher than we had wanted.

I can answer more on that if you want, but I think that is probably what you were looking for.

Kevin M. Dotts

Heath, what we are learning as we go through the economics on building out these markets, again as I talked with Anthony a few minutes ago, we talked about the fact that the contribution margin on a resale basis we think is in roughly the $10 range per subscriber. We think the acquisition cost is going to be very close to a narrow band subscriber. We are looking at a large segment of our narrow band subscribers converting over to this higher speed product. Think about it, right, we are charging the same amount of price but we are getting them almost 20 times the speed, so we feel very good that the acquisition cost or MAC cost or SAC cost, whatever you want to call it, will be reasonable. Today in narrow band, that is about $175. We have talked about that.

From the network build-out perspective, we are in about the $40, $42 per household cover range as far as the CapEx and building out the network. The great thing is once you have that network built out, you can bring on subscribers and really begin to leverage that network.

I think earlier, as an example, we talked again about Philadelphia. We have said it would be about a $15 million build-out. Based on our learning experiences in New Orleans, Milpitas, Anaheim, and as we build out the proof of concept area within Philadelphia, those economics are kind of holding true, as we expected.

Heath Terry - Credit Suisse

When you are looking at that $40 to $42 per household pass, how does that change when you go from a market like Philly, which is relatively population dense, to a market like Atlanta, where you have a little more spread out population?

Michael C. Lunsford

Well, we will not always do 100% coverage in market. That is something that we will negotiate up front with the city, so we will not let the CapEx get too far outside of the acceptable band.

What really drives this is the number of towers that you have to put up in any given city, which is driven by not just the geographic spread but also hills, trees, other things like that. So a market like a San Francisco is actually probably a little more difficult than an Anaheim, but given that it is more dense, it makes sense.

So each time that we go into one of these cities, we will actually do a pretty comprehensive analysis of what it will take from a CapEx standpoint and we will back away from that city if it does not make sense.

Heath Terry - Credit Suisse

Thank you.

Operator

The next question comes from Bryan Goldberg.

Bryan Goldberg - Bear Stearns

Thanks. Just a follow-up question on the municipal WiFi. I guess from a CapEx standpoint, your earlier comments suggest you are going to be adding over a million households this year. Assuming the $40 to $42 per household covered, should we be expecting somewhere in the range of $50 million to $55 million in CapEx associated with municipal WiFi this year?

Kevin M. Dotts

I think it is a little bit -- I want to suggest it is a little bit higher than that, Bryan. I am thinking that the CapEx invested on MUNI is going to be in the 70 to 80 range. The thing to note there, back in the fourth quarter, we entered into a lease agreement with GE Capital, so some of that will show up before under a capital lease version. It will show up in our books as CapEx, but from a cash flow perspective, it will actually be slightly better.

About 70% of the municipal CapEx investment will be applicable to the lease.

Bryan Goldberg - Bear Stearns

Okay, and one other follow-up question. In terms of the 12,000 voice customers you added in the quarter, could we get a breakout of the mix? Are these line-powered voice customers?

Kevin M. Dotts

Absolutely. Let’s see here -- okay, Bryan, that is for the fourth quarter, it was about two-thirds LPV and one-third ETV.

Bryan Goldberg - Bear Stearns

Okay. Thank you very much.

Michael C. Lunsford

I think you will see over time that continue to weigh much more towards LPV.

Operator

(Operator Instructions)

Your next question comes from Chris Rowen.

Chris Rowen - SunTrust Robinson Humphrey

Just an accounting issue, the $6.4 million estate charge, does that lower the adjusted EBITDA or is that excluded from adjusted EBITDA?

Michael C. Lunsford

In our straight adjusted EBITDA, that is a negative impact, so it is included in the guidance of $7 million to $12 million of total EBITDA.

Chris Rowen - SunTrust Robinson Humphrey

Great, thanks. And then, could you give us a neighborhood estimate for municipal WiFi sub adds for 2007?

Kevin M. Dotts

I do not think we are giving out specific subs by these various growth elements at this point, excluding HELIO. If you look at the past history, the way I would think about this is, Chris, we have been losing on a narrow band premium subscriber about 150,000 to 175,000 narrow band premium subscribers. With the decline in churn and narrow band premium, expect that to come down. That will get lower per quarter.

When you think about the broadband, traditional access elements of cable and DSL, right now those are relatively flat. We expect some moderate growth, but let’s call it relatively small. With People PC, the value brand, at this point we are modeling that as being relatively flat year over year, as the growth there will be slowing.

The growth products though, voice and municipal WiFi, would then add and offset that to get to that 75,000 to 175,000 net loss of subscribers. Does that help?

Chris Rowen - SunTrust Robinson Humphrey

Yes, I guess I can back into something. Then, lastly, on the HELIO subscribers, can you give us an indication, is that 10% coming from the Korean-American market or 60%? How much of that is driven by the Korean language people?

Michael C. Lunsford

I don’t think we can give you a specific, but the Korean portion is a very small portion of the total.

Chris Rowen - SunTrust Robinson Humphrey

Okay. Thanks a lot.

Operator

Your next question comes from Jim Friedland.

Jim Friedland - SG Cowen & Co.

Thanks. First, just a couple of questions on stock-based comp. Do you have a projection for ’07? Second is on CapEx. Can you give us a range there? Then third, with AOL easing up on the marketing spend, have you noticed any kind of a meaningful impact? Is that something that contributed to the better churn in the premium narrow band business? How do you expect AOL’s pulling out of the market to impact that business in ’07, ’08? Thanks.

Kevin M. Dotts

Tim, with regard to the stock-based compensation, if you think about 2006, we incurred I think it’s about $14 million of FAS-123R expense. That would be flat year over year with the one exception of the impact related to the acceleration of vesting to Garry’s estate. So that was in itself about $3.5 million on top of let’s say $14 million, assuming that we have no reason to believe at this point that $14 million will change year over year.

Then, because we allowed the estate to have access to acting on those options over an extended period of time out to the end of effectively what was Garry’s contract, that was an additional 1.4 charge, so 14, 3.5, plus 1.4 is kind of what the total stock-based compensation would look like for 2007.

Jim Friedland - SG Cowen & Co.

Okay, and a range for CapEx?

Kevin M. Dotts

So for CapEx, from that perspective, historically in our existing core access business, again I expect that to be as it has been historically, roughly the $30 million range. Then, for the municipal WiFi business, we said that would be about 60 to 80 or more, and again about 70% of that MUNI WiFi will probably be on a capital lease, so it will not have as much of a cash impact.

Jim Friedland - SG Cowen & Co.

Okay, and then, any positive impact from AOL yet?

Michael C. Lunsford

We are seeing a positive on our People PC brand, which is where we are doing most of our dial-up marketing right now. We really do not do a whole lot of marketing on dial-up under the EarthLink brand at this point, although we are still fairly active in the sales channels. I would expect that to continue, though again, dial is a bit of a declining business, but we will see some benefit there. Is that enough of an answer or do you want more?

Jim Friedland - SG Cowen & Co.

Yes, sure, thanks.

Michael C. Lunsford

Okay, I think we are going to end there. I want to thank everyone, particularly those of you asking questions, Youssef, Anthony, Heath, Bryan, Chris, Jim. We always appreciate that. Looking forward to this year. I think we did well last year and we are out to prove the business to you. Thanks a lot.

Operator

This concludes today’s conference call. You may now disconnect.

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