Earthlink 2003 Annual Report Download - page 46

equipment, activation and equipment revenues and related costs are recognized over the estimated life of the customer.
EarthLink maintains relationships with certain telecommunications partners (including cable companies) in which it provides services to
customers using the "last mile" element of the telecommunication providers' networks. The term "last mile" generally refers to the element of
telecommunications networks that is directly connected to homes and businesses. In these instances, EarthLink evaluates the criteria outlined in
Emerging Issues Task Force ("EITF") Issue No. 99-19, "Reporting Revenue Gross as a Principal versus Net as an Agent," in determining
whether it is appropriate to record the gross amount of revenue and related costs or the net amount due it from the telecommunications partner.
Generally, when EarthLink is the primary obligor in the transaction with the subscriber, has latitude in establishing prices, is the party
determining the service specifications or has several but not all of these indicators, EarthLink records the revenue at the amount billed the
subscriber. If EarthLink is not the primary obligor and/or the telecommunications partner has latitude in establishing prices, EarthLink records
revenue associated with the related subscribers on a net basis, netting the cost of revenue associated with the service against the gross amount
billed the customer and recording the net amount as revenue.
Content, commerce and advertising revenues include amounts derived from selling other companies' products and/or services to EarthLink
subscribers, subscribers using and/or buying other vendors' products and/or services, and allowing companies to advertise to EarthLink's
subscribers, among other activities. Content, commerce and advertising revenues are recorded based on the per unit contractual rate and the
number of units sold, number of subscriber impressions, or number of subscriber purchases or actions.
Cost of Revenues
Cost of revenues include telecommunications service and equipment costs and sales incentives. Telecommunications service and
equipment costs include telecommunications fees and network operations costs incurred to provide the Company's Internet access services; fees
paid to content providers for information provided on the Company's online properties, including the Company's Personal Start Page™; the
costs of equipment sold to customers for use with the Company's narrowband and broadband Internet access services; and activation and
deactivation fees paid to the Company's network providers for the provisioning and disconnection of services.
Sales incentives include the cost of promotional products and services provided to potential subscribers as introductory offers, including
free Internet access on a trial basis; free cameras, modems and other hardware; and starter kits. EarthLink accounts for sales incentives in
accordance with EITF Issue No. 01-09, "Accounting for Consideration Given by a Vendor to a Customer (Including a Reseller of the Vendor's
Products)," which requires the costs of sales incentives to be classified as cost of revenues. Prior to the adoption of EITF Issue No. 00-14,
"Accounting for Certain Sales Incentives," on January 1, 2002, EarthLink classified the costs of these sales incentives as sales and marketing
expenses. As required by EITF Issue No. 01-09, the costs of sales incentives in prior periods have been reclassified to cost of revenues to
conform to the current year presentation.
F-8
Regulatory Risk
EarthLink purchases broadband access from incumbent local exchange carriers, competitive local exchange carriers 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 the Company's contracts with broadband access providers.
Source of Supplies
The Company's business substantially depends on the capacity, affordability, reliability and security of third-party telecommunications
and data service providers. Only a small number of providers offer the network services the Company requires, and the majority of its
telecommunications services are currently purchased from several telecommunications service providers. In addition, several
telecommunications services providers have experienced financial difficulties and have filed for bankruptcy and, consequently, may be unable
to perform satisfactorily or to continue to offer their services. Although management believes that alternate telecommunications providers
could be found in a timely manner, any disruption of these services could have a material adverse effect on the Company's financial position,
results of operations and cash flows.
The Company also relies on the reliability, capacity and effectiveness of its outsourced contact center service providers. The Company
purchases contact center services from several geographically dispersed service providers. The contact center service providers may become
subject to financial and political risks beyond the Company's or the providers' control which could jeopardize their ability to deliver services.
Although management believes that alternate contact center service providers could be found in a timely manner, any disruption of these
services could have a material adverse effect on the Company's financial position, results of operations and cash flows.
Advertising
Advertising costs are included in sales and marketing. Advertising expense includes a variety of programs and strategies including
broadcast campaigns in television and radio, direct mail, co
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marketing and bundling agreements, print publications, and online promotion and