ISP Price Wars Taking a Toll on EarthLink

The company's mixed second-quarter numbers highlight the challenges at rival America Online.
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At EarthLink (ELNK) , the good news is in lower costs, not higher revenue.

Reporting its second-quarter earnings Tuesday, the Internet service provider missed top-line estimates and lowered sales forecasts for the rest of the year. At the same time, however, EarthLink beat bottom-line forecasts and tightened full-year guidance for earnings before interest, taxes, depreciation and amortization.

The results and outlook reflect pricing pressure in both dial-up service and high-speed, or broadband, Internet connections, as well as the company's continuing efforts to cut operational costs. The outlook -- which includes EarthLink's cutting subscriber growth forecasts -- also results from a proposed change in EarthLink's agreement to provide broadband Internet service to customers of cable operator

Charter Communications

(CHTR) - Get Report

.

The new deal and new numbers serve also as a reminder of the business difficulties faced by

AOL Time Warner's

(AOL)

America Online, the nation's largest Internet service provider. Like EarthLink, AOL faces cannibalization from discount dial-up ISPs, such as

United Online

(UNTD)

. And as with EarthLink's rejiggered deal with Charter, AOL is focusing on selling its broadband service as an add-on to high-speed connections offered by cable operators or telcos, not -- as AOL previously envisioned -- as an integral part of the net connection package offered to cable modem or DSL subscribers.

On Tuesday, EarthLink's shares fell 10 cents to trade at $7.23.

Mixed Results

For the second quarter ended June 30, EarthLink reported revenue of $352.3 million, up 5% from a year ago but shy of the Thomson First Call estimate of $359 million. Adjusted EBITDA -- excluding facility exit costs -- of $29.8 million was up from $12 million a year ago, and better than the company's three-month-old forecast of EBITDA that would be at best "modestly above" the first quarter's $22 million.

Net earnings, before acquisition-related amortization and preferred stock dividends, amounted to $11.4 million, or 7 cents a share, compared with a 7-cent loss per share in the second quarter of 2002 and the First Call estimate of 3 cents per share.

In accordance with generally accepted accounting principles, EarthLink lost $14.5 million in the quarter, compared with a loss of $34.9 million a year earlier.

Looking ahead, EarthLink predicts $1.4 billion in revenue for the year, down from its prior range of $1.44 billion to $1.5 billion. Analysts had been expecting $1.45 billion.

The company now says its adjusted EBITDA will amount to $102 million to $114 million for the year, a narrower range than the $95 million to $115 million it forecast previously.

Rather than ending the year with a range of 5.1 million to 5.3 million paying subscribers, the company is now aiming for a range of 5 million to 5.15 million.

Charter Service

Behind the subscriber decline is the renegotiated deal with Charter. Instead of providing wholesale Internet services to the cable company in certain markets, EarthLink will offer a premium service -- one that perhaps will be expanded to all Charter territories. During a transition period, EarthLink will continue to provide wholesale services to Charter at a reduced fee, and is cutting 152,000 Charter subscribers from its rolls until they choose to subscribe to the new "EarthLink Experience" offering.

EarthLink reported second-quarter gains in broadband subscribers and in subscribers to its People PC discount dial-up brand. But the company lost roughly 130,000 premium dial-up subscribers, excluding those who traded up to broadband, up from 101,000 such losses in the first quarter, estimates Jefferies analyst Richard Klugman.

In an indication of narrowband pricing pressure, the company says the Web accelerator tool in its EarthLink Plus service will become a standard part of premium dial-up service in the third quarter, rather than the $7-per-month add-on it has been until now.

But in a reflection of lower telecommunications costs for narrowband and broadband, EarthLink reported improved gross margins in the second quarter.