Earthlink 2005 Annual Report Download - page 45

Cost of revenues
Telecommunications service and equipment costs are the primary component of EarthLink’s cost of revenues and consist of
telecommunications fees, set-
up fees, network equipment costs incurred to provide our Internet access services and depreciation of our network
equipment. Telecommunications service and equipment costs also include the cost of Internet appliances sold, including wireless devices and
personal computers. Telecommunications service and equipment costs decreased 17% from $519.1 million during the year ended December 31,
2003 to $431.2 million during the year ended December 31, 2004, and decreased as a percentage of total revenues from 37.0% to 31.2%.
Telecommunications service and equipment costs decreased 15% to $366.7 million during the year ended December 31, 2005, and decreased as
a percentage of total revenues to 28.4%. The decreases in telecommunications service and equipment costs were due to decreases of 22% and
15% in average monthly telecommunications service and equipment cost per subscriber during the years ended December 31, 2004 and 2005,
respectively. The decrease in telecommunications service and equipment costs per subscriber during the year ended December 31, 2004 was
partially offset by an increase of 6% in average subscribers.
The decreases in average monthly costs per subscriber were primarily 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. Contributing to the decrease during the year ended December 31, 2004 was a $25.8 million decline in
equipment and related costs due to the discontinuation of certain products including MailStation and personal computers bundled with Internet
access and a $14.8 million decrease in depreciation expense due to network-related assets becoming fully depreciated, lower capital
expenditures in recent years and $2.4 million of depreciation expense in 2003 associated with the write-down of our OmniSky platform.
Contributing to the decrease during the year ended December 31, 2005 was a $6.1 million decline in equipment and related costs, primarily due
to the transfer of wireless operations to HELIO in March 2005, and an $8.4 million decrease in depreciation expense due to network-related
assets becoming fully depreciated and lower capital expenditures in recent years. Also contributing to the decrease during the year ended
December 31, 2005 was the shift in the mix of our broadband customer base to wholesale and certain retail cable customers who have nominal
telecommunications service and equipment costs. Although we have experienced declines in depreciation expense for network-related assets
over the past three years, we expect an increase in 2006 due to an increase in capital expenditures resulting from implementing our VoIP and
municipal wireless broadband initiatives.
Our retail broadband access has both a higher telecommunications cost of revenue per subscriber and a lower estimated gross profit
margin percentage than our other principal forms of Internet access and related services. Even though broadband subscribers increased from
25% of total subscribers as of December 31, 2004 to 30% of total subscribers as of December 31, 2005, 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 may be additional, although limited, 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. These initiatives may offset the negative effect expected to result from broadband continuing to grow as a portion
of our overall business. As a result, we expect to be able to maintain current levels of telecommunications service and equipment costs as a
percentage of total revenues for our core access services throughout 2006.
EarthLink’s principal providers for narrowband telecommunications services are Level 3 Communications, Inc. and Qwest Coporation,
and our largest providers of broadband connectivity are
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