Earthlink 2003 Annual Report Download - page 23

$519.1 million during the year ended December 31, 2003, and decreased as a percentage of total revenues from 40.1% to 37.0%.
Telecommunications service and equipment costs for the year ended December 31, 2003 includes a $2.4 million write-down of the OmniSky
platform related to our decision to discontinue providing services to certain customers supported by the OmniSky platform and a $4.8 million
write-down of MailStation hardware related to our decision to cease actively marketing MailStation products and services. The decrease in
telecommunications service and equipment costs was due to an 8% decrease in average monthly telecommunications service and equipment
cost per subscriber offset by a 3% increase in average subscribers.
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The decrease in average monthly costs per subscriber was due to improvements in both narrowband and broadband telecommunications
costs. This was a result of more favorable agreements with telecommunications service providers as well as optimizing network capacity to
reduce costs. In general, the telecommunications cost per subscriber has declined over time, resulting from improvements in communications
technology, the increasing scale of Internet-related business, and competition among telecommunications providers. However, the intensity of
competition and wholesale telecommunications pricing, which have benefited EarthLink, have caused some telecommunications companies to
experience financial difficulty. EarthLink's prospects for maintaining or further improving telecommunications costs, particularly for
narrowband services, could be negatively affected if one or more of EarthLink's key telecommunications providers were to experience serious
enough difficulties to impact service availability, or if telecommunications bankruptcies generally reduced the level of competition among
telecommunications providers.
Based on management's estimates, broadband access has both a higher telecommunications cost of revenue per subscriber and a lower
gross profit margin percentage than our other principal forms of Internet access and related services. Even though broadband subscribers
increased from 16% of total subscribers at December 31, 2002 to 20% of total subscribers at December 31, 2003, telecommunications cost per
subscriber decreased sufficiently in both our narrowband and broadband offerings to cause total average monthly telecommunications service
and equipment cost per subscriber to decrease. We expect that there will be additional opportunities to reduce such costs by continuing to
eliminate higher cost providers, reducing costs from the remaining vendors, and achieving higher utilization of existing telecommunications
capacity. We expect these initiatives will offset the negative effect on our gross profit margin percentage of broadband continuing to grow as a
portion of our overall business. As a result, we expect to be able to maintain or slightly increase our gross profit margin percentage during
2004. Beyond 2004, gross profit margin percentages may decrease as a result of the expected continuing growth of broadband as a percentage
of our total business.
EarthLink's principal providers for narrowband telecommunications services are Level 3 Communications, Inc. and Sprint, and our largest
provider of broadband connectivity is Covad Communications Group, Inc. We also do lesser amounts of business with a wide variety of local,
regional and other national providers. EarthLink purchases broadband access from ILECS, CLECs and cable providers. Please refer to
"Regulatory Environment" in the Business section of this 10-K for a discussion of the regulatory environment as well as a discussion regarding
our contracts with broadband access providers.
Cost of revenues also includes sales incentives. We frequently offer sales incentives such as free Internet access on a trial basis, modems
and starter kits as introductory offers. Sales incentives decreased 44% from $37.7 million during the year ended December 31, 2002 to
$21.2 million during the year ended December 31, 2003 due to declines in broadband equipment prices, including support provided by
broadband network partners to offset such costs, and a shift in emphasis from sales incentives to reduced price introductory offers to attract
new subscribers.
Sales and marketing
Sales and marketing expenses consist of advertising, direct response mailings, bounties paid to channel partners, sales and marketing
personnel costs, and promotional materials. Sales and marketing expenses increased 3% from $373.5 million during the year ended
December 31, 2002 to $383.0 million during the year ended December 31, 2003, but decreased slightly as a percent of total revenues from 28%
to 27%. The increase in total sales and marketing expenses was primarily due to direct and performance-based sales and marketing efforts for
our narrowband, broadband and value-priced access services and increased support for new sales channels. These increases were partially
offset by declines in sales and marketing expenses associated with our EarthLink Everywhere initiative and our MailStation products and
services.
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Operations and customer support
Operations and customer support expenses consist of costs associated with technical support and customer service, providing our
subscribers with toll-free access to our technical support and customer service centers, maintenance of customer information systems, software
development and network operations. Operations and customer support expenses decreased from $324.6 million during the year ended
December 31, 2002 to $297.0 million during the year ended December 31, 2003. The decrease was a result of decreased personnel and