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FORM 10-K
EARTHLINK INC
(Annual Report)
Filed 3/31/2003 For Period Ending 12/31/2002
Address 1375 PEACHTREE STREET SUITE 400
ATLANTA, Georgia 30309
Telephone 404-815-0770
CIK 0001102541
Industry Computer Services
Sector Technology
Fiscal Year 12/31

Table of contents

  • Page 1
    EARTHLINK INC FORM 10-K (Annual Report) Filed 3/31/2003 For Period Ending 12/31/2002 Address Telephone CIK Industry Sector Fiscal Year 1375 PEACHTREE STREET SUITE 400 ATLANTA, Georgia 30309 404-815-0770 0001102541 Computer Services Technology 12/31

  • Page 2
    ... Its Charter) Delaware (State of Incorporation) 58-2511877 (I.R.S. Employer Identification No.) 1375 Peachtree St., Atlanta, Georgia 30309 (Address of Principal Executive Offices, Including Zip Code) (404) 815-0770 (Registrant's telephone number, including area code) Securities registered pursuant...

  • Page 3
    ... on June 28, 2002 was $931,986,546. As of February 28, 2003, 152,398,509 shares of common stock were outstanding. Portions of the Proxy Statement to be filed with the Securities and Exchange Commission on or about April 7, 2003 and to be used in connection with the Annual Meeting of Stockholders...

  • Page 4
    ... Internet access and related services, including narrowband access, wireless access, broadband or high speed access, and web hosting. We focus on providing a high-quality user experience for our users through reliable access, superior customer service and support, and useful features like email, web...

  • Page 5
    ... broadband subscriber base. Increase the range of services offered We are focused on deploying products and services that enhance customers' Internet experiences as well as extending Internet access beyond the personal computer. During 2002, we launched a number of applications and services designed...

  • Page 6
    ..., 2002, which represented 76% of total revenues for the year. Broadband access Broadband access revenues consist of fees charged for high-speed, high-capacity access services including DSL, cable, satellite, fixed wireless and dedicated circuit services; installation fees; early 3 termination fees...

  • Page 7
    ...We currently waive one month of standard access service fees for each customer who refers a new customer to EarthLink's service. Services Our primary service offerings include narrowband Internet access, including premium and value-priced dial-up access over traditional telephone lines and wireless...

  • Page 8
    ... Web Mail application; a task panel that provides one-click access to the Web, email and personal web space; and a cleaner, faster-loading Personal Start Page. The profile/location manager feature of TotalAccess 2003 sets up and maintains multiple user and location profiles. For example, subscribers...

  • Page 9
    ...access their electronic files from virtually anywhere with the Remote Access service. EarthLink Firewall. High-speed Internet subscribers using a cable or DSL connection can download ZoneAlarm® free-ofcharge or purchase ZoneAlarm Pro. Pop-Up Blocker In August 2002, we enhanced our service offering...

  • Page 10
    .... Cable providers are not required by current law to make last mile access available to ISPs like EarthLink; however, Time Warner Cable was required to make last mile access available over its cable facilities as a condition of completing a merger. In November 1999, the FCC issued an order which...

  • Page 11
    ... service offerings; free or value-priced ISPs such as United Online; cable television companies providing broadband access, including Comcast, Charter Communications and Cox Communications; and utility and local and long-distance telephone companies. Competition is likely to continue increasing...

  • Page 12
    ... support a variety of Sprint-branded retail Internet services, such as Sprint's broadband services. We do this through a wholesale arrangement with Sprint. Sprint continues to sell EarthLink-branded dial-up Internet access service, though Sprint may now, at its election, create a Sprint-branded dial...

  • Page 13
    ... of 2003, including closing four call center facilities. We expect the implementation of the plan will result in a net reduction of approximately 920 employees, primarily customer support personnel. Available Information EarthLink files annual, quarterly, and current reports, proxy statements, and...

  • Page 14
    ... available free of charge on or through its Internet web site (http://www.earthlink.net) its Annual Report on Form 10K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, and, if applicable, amendments to those reports filed or furnished pursuant to Section 13(a) of the Securities Exchange...

  • Page 15
    ...$ $ The last reported sale price of EarthLink's common stock on the Nasdaq National Market on February 28, 2003 was $4.97 per share. Holders There were approximately 2,031 holders of record of EarthLink's common stock on February 28, 2003. Dividends We have never declared or paid cash dividends on...

  • Page 16
    ... network providers may be unwilling or unable to provide Internet access; (11) that we may be unable to maintain or increase our customer levels if we do not have uninterrupted and reasonably priced access to local and longdistance telecommunications systems for delivering dial-up and/or broadband...

  • Page 17
    ...combined company to differentiate it from the former EarthLink Network. Our base of approximately 5.0 million paying subscribers makes us one of the largest ISPs in the U.S. Our primary service offerings are narrowband and broadband or high-speed Internet 17 access, web hosting, and advertising and...

  • Page 18
    ... from EarthLink for providing last mile broadband access to certain broadband subscribers. In the third quarter of 2001, we started providing services to subscribers via the Time Warner Cable network, and as of June 30, 2002, our full package of high-speed Internet access, content, applications and...

  • Page 19
    ...'s cable network to offer high-speed Internet access services in the Seattle and Boston area markets. In connection with the agreement, AT&T Broadband receives compensation from EarthLink for providing last mile broadband access to certain broadband subscribers. EarthLink launched high-speed service...

  • Page 20
    ... and accounting services, the acceleration of unamortized costs associated with a line of credit and convertible debt, severance costs and non-cash accelerated compensation expense resulting from the merger of EarthLink Network and MindSpring. We have made investments in a number of other companies...

  • Page 21
    ... revenues consist of monthly fees charged to customers for dial-up Internet access. In addition, narrowband access revenues include monthly service fees, any associated equipment revenues for Internet appliances, and wireless access services provided as part of our "EarthLink Everywhere" initiative...

  • Page 22
    ...rates of customer churn. Broadband access revenues Broadband access revenues consist of fees charged for high-speed, high-capacity access services including DSL, cable, satellite and dedicated circuit services; installation fees; termination fees; and fees for equipment. Broadband revenues increased...

  • Page 23
    ... telecommunications and cable partners. We have agreements with varying terms with all of our significant broadband network providers. Our contract with Sprint to provide wholesale broadband services is not exclusive and has annual windows for termination and renegotiation. Our contract with Charter...

  • Page 24
    ... 2002, respectively. Average monthly telecommunications service and equipment costs per subscriber also increased due to costs associated with personal computers recorded in connection with the sale of Membership Packages. PeoplePC offers Membership Packages allowing customers to purchase a personal...

  • Page 25
    ... support Operations and customer support expenses consist of costs associated with (i) technical support and customer service, (ii) providing our subscribers with toll-free access to our technical support and customer service centers, (iii) maintenance of customer information systems, (iv) software...

  • Page 26
    ... assets associated with the acquisition of PeoplePC $ 126,260 7,281 42,956 $ 176,497 Facility exit costs On October 30, 2002, EarthLink announced it would close its Phoenix, Arizona call center facility to consolidate operations and reduce overall costs. The plan for the closure of the Phoenix...

  • Page 27
    ... increase to traditional EarthLink customers as well as the conversion of OneMain and other acquired subscribers to standard EarthLink pricing plans, (ii) the migration of narrowband subscribers to our broadband service, and (iii) the continued maturing of the market for narrowband Internet access...

  • Page 28
    ... the increasing acceptance and availability of broadband access via DSL and cable offered at prices significantly less expensive than dedicated circuits. However, the effect of the increase in subscribers was partially offset by a decrease in average monthly revenues per broadband subscriber during...

  • Page 29
    ... of former OneMain customers from lower rate plans to our new pricing. We experienced significantly higher churn for this group. Professional fees increased approximately $1.7 million as a result of costs associated with the offering of 18.4 million shares of EarthLink stock by Sprint and certain...

  • Page 30
    ... the merger of EarthLink Network and MindSpring: Investment banking fees Printing, filing, mailing, proxy solicitation, legal, accounting and advisory fees Acceleration of unamortized costs associated with a line of credit and convertible debt Severance costs and accelerated compensation expense...

  • Page 31
    .... The Cidco Plan called for the net reduction of approximately 49 positions in operations and customer support, sales and marketing, and in general and administrative departments. As of December 31, 2002, EarthLink had paid all severance amounts in conjunction with the termination of all 49...

  • Page 32
    .... The PeoplePC Plan called for the net reduction of approximately 13 positions in 35 operations and customer support, sales and marketing, and in general and administrative departments. As of December 31, 2002, 11 of these positions had been terminated as a result of the PeoplePC Plan. The costs...

  • Page 33
    ... remaining call centers in Atlanta, Georgia; Harrisburg, Pennsylvania; and Roseville, California as well as to our existing outsourced call center providers. We anticipate the plan will result in a net reduction of approximately 920 employees, primarily customer support personnel. EarthLink expects...

  • Page 34
    ...of the lease term. Access to the Internet for customers outside of our base of owned POPs is provided through capacity leased from a number of third-party providers under non-cancelable network service agreements expiring in various years through 2008. At December 31, 2002, we had approximately $382...

  • Page 35
    ... customers terminate their service contracts. PeoplePC bundle revenues PeoplePC hardware revenues represent 0.6% of total revenues for the year ended December 31, 2002. PeoplePC sells personal computers and prepaid Internet access bundled together in one package. We allocate the payment received...

  • Page 36
    ... September 2000 and PeoplePC in July 2002. The following outlines policies related to significant estimates of fair value of assets acquired and liabilities assumed: Deferred revenue acquired EarthLink generally records deferred revenue for commitments to provide service to customers over a prepaid...

  • Page 37
    ... with a net book value of $119.8 million were not impaired because the value of EarthLink's outstanding securities plus its liabilities exceeded its total assets by $174.5 million. If EarthLink's stock price as quoted on the Nasdaq national market was less than $4.21 per share at the time of the...

  • Page 38
    ... 2002, the FASB issued SFAS No. 148, "Accounting for Stock-Based Compensation-Transition and Disclosure." SFAS No. 148 amends SFAS No. 123, "Accounting for Stock-Based Compensation," to provide alternative methods of transition for a voluntary change to the fair value based method of accounting...

  • Page 39
    ... and owners of more than 10% of EarthLink's common stock with the reporting requirements of Section 16(a) of the Securities Exchange Act of 1934, as amended, will be set forth under the caption "Executive Officers-Compliance with Section 16(a) of the Securities Exchange Act of 1934" in the above...

  • Page 40
    ... - Offer Agreement by and among PeoplePC Inc., EarthLink, Inc., and EL Sub, Inc. dated as of June 9, 2002 (incorporated by reference to Exhibit 2.1 of EarthLink, Inc.'s Report on Form 8-K, dated June 11, 2002-File No. 001-15605). - Amended and Restated Certificate of Incorporation of EarthLink, Inc...

  • Page 41
    .... Employee Stock Purchase Plan (incorporated by reference to Exhibit 99.1 of EarthLink, Inc.'s Registration Statement on Form S-8-File No. 333-83870). - (a) Netscape Communications Corporation Internet Service Provider Navigator Distribution Agreement, dated May 31, 1996, between EarthLink Network...

  • Page 42
    47 10.9 - Internet Wizard Sign-Up Agreement, between EarthLink Network, Inc. and Microsoft Corporation, dated August 16, 1996 (incorporated by reference to Exhibit 10.19 of EarthLink Network, Inc.'s Registration Statement on Form S-1-File No. 33315781). - Office Lease Agreement dated November 16, ...

  • Page 43
    ...of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of registrant and in the capacities and on the dates indicated. Date: March 31, 2003 /s/ CHARLES G. BETTY Charles G. Betty, Chief Executive Officer and Director (principal executive officer...

  • Page 44
    ... CEO PURSUANT TO SECURITIES EXCHANGE ACT RULES 13a-14 AND 15d-14 AS ADOPTED PURSUANT TO SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002 I, Charles G. Betty, the Chief Executive Officer of EarthLink, Inc., certify that: 1. 2. I have reviewed this annual report on Form 10-K of EarthLink, Inc.; Based on...

  • Page 45
    ... flows of the registrant as of, and for, the periods presented in this annual report; The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and have...

  • Page 46
    .... /s/ Ernst & Young LLP Atlanta, Georgia January 28, 2003 F-2 EARTHLINK, INC. CONSOLIDATED BALANCE SHEETS (in thousands, except per share data) December 31, 2001 ASSETS Current assets: Cash and cash equivalents Investments in marketable securities Accounts receivable, net of allowance of $5,017 and...

  • Page 47
    ... 2001 (in thousands, except per share data) 2002 Revenues: Narrowband access Broadband access Web hosting Content, commerce and advertising Total revenues Operating costs and expenses: Telecommunications service and equipment costs Sales incentives Total cost of revenues Sales and marketing $ 833...

  • Page 48
    Operations and customer support General and administrative Acquisition-related amortization Facility exit costs Intangible asset write-off Merger related charges Total operating costs and expenses 297,027 106,148 132,448 - - 33,967 1,381,431 339,490 127,849 217,483 - 11,252 - 1,601,458 324,555 ...

  • Page 49
    ... to net cash (used in) provided by operating activities: Depreciation and amortization Loss on disposal of fixed assets, including non-cash facility exit costs Loss on investments in other companies Write-off of intangible assets (Increase) decrease in net accounts receivable Decrease (increase) in...

  • Page 50
    ... "Company") is a leading Internet service provider ("ISP") providing reliable nationwide Internet access and related value-added services to its individual and business customers. The Company was formed in February 2000 as a result of the merger of EarthLink Network, Inc., ("EarthLink Network"), and...

  • Page 51
    ..."), cable, satellite, fixed wireless and dedicated circuit services. Broadband access revenues also include installation, shipping, and equipment revenues as well as activation and early termination fees. Web hosting revenues consist of fees earned by leasing server space and providing web services...

  • Page 52
    ...'s online properties, including the Company's Personal Start Pageâ„¢. EarthLink provides Internet access service through both its managed network and third-party network points of presence ("POPs"). Telecommunications service and equipment costs also include the costs of equipment sold to customers...

  • Page 53
    ..., 2000 2001 (in thousands) 2002 Convertible preferred stock Options and warrants Total 43,386 22,166 65,552 26,951 21,022 47,973 17,979 28,356 46,335 Stock-Based Compensation The Company accounts for stock-based compensation issued to employees using the intrinsic value method as prescribed by...

  • Page 54
    ... on month-to-month service plans. The Company offers prepay plans that allow customers to prepay for services for periods of up to two years. The Company's wholly-owned subsidiary, PeoplePC Inc. ("PeoplePC"), offers a package that includes a personal computer and prepaid Internet access services for...

  • Page 55
    ... in marketable securities and trade receivables approximate their fair values. Property and Equipment Property and equipment are stated at cost less accumulated depreciation. Depreciation and amortization expense is determined using the straight-line method over the estimated useful lives of the...

  • Page 56
    ... Internet access and related services. In connection with the Strategic Alliance, on June 5, 1998, EarthLink Network issued 13.2 million shares of Series A convertible preferred stock to Sprint valued at $135 million in exchange for (i) approximately 130,000 Sprint Internet Passport subscribers...

  • Page 57
    ...full package of high-speed Internet access, content, applications and functionality was available in all 39 markets for which the contract allows EarthLink to offer its services, including the New York and Los Angeles markets. In connection with the agreement, Time Warner Cable receives compensation...

  • Page 58
    ... launched high-speed service in the Seattle and Boston markets over AT&T Broadband's network in July 2002 and October 2002, respectively. PeoplePC In July 2002, EarthLink purchased, via tender offer, the outstanding stock of PeoplePC. PeoplePC provides value-priced Internet access using a cost...

  • Page 59
    ... households in the west, southwest and upper midwest. In connection with the agreement, SBC receives compensation from EarthLink for providing last mile broadband access to certain broadband subscribers. To date, the Company has launched services in more than 28 of the 53 markets and anticipates...

  • Page 60
    ... the merger of EarthLink Network and MindSpring: Investment banking fees Printing, filing, mailing, proxy solicitation, legal, accounting and advisory fees Acceleration of unamortized costs associated with a line of credit and convertible debt Severance costs and accelerated compensation expense...

  • Page 61
    .... The Cidco Plan called for the net reduction of approximately 49 positions in operations and customer support, sales and marketing, and in general and administrative departments. As of December 31, 2002, EarthLink had paid all severance amounts in conjunction with the termination of all 49...

  • Page 62
    ... for the year ended December 31, 2002: Facility Exit Costs Non-Cash Items Balance December 31, 2002 Payments (in thousands) Phoenix call center facility exit costs: Severance and personnel related costs Real estate and telecommunications contract termination costs Write-off abandoned and disposed...

  • Page 63
    ...Inc. customer base NETCOM On-Line Communications Services Inc. customer base Other acquired customer bases Other definite life intangible assets Total customer base and other definite life intangibles Total intangible assets $ Gross Carrying Amount As of December 31, 2002 Net Book Value Accumulated...

  • Page 64
    ... - 124 - 572 $ 110,414 1,490 21,468 - 133,372 F-24 Maturities of available-for-sale securities were as follows at December 31, 2001 and 2002: As of December 31, 2001 Amortized Cost Fair Value Amortized Cost (in thousands) 2002 Fair Value Due within one year Due after one year and within two years...

  • Page 65
    ... 2000, at the time of the merger of EarthLink Network and MindSpring, MindSpring had issued and outstanding $180.0 million aggregate principal amount of its 5% Convertible Subordinated Notes due 2006. The notes were convertible into shares of common stock of MindSpring at any time prior to their...

  • Page 66
    ... services from certain individuals over a period of nine months. Under the agreement, the shares were issued as certain milestones were met. During the year ended December 31, 2001, the Company issued 140,000 shares of its common stock valued at $1.9 million based on the fair value of EarthLink...

  • Page 67
    ... to any payment or distribution in respect of other shares of the Company's capital stock, an amount per share equal to the liquidation value per share. Dividends Sprint receives dividends on Series A and B convertible preferred stock at an annual rate of 3% of the stated liquidation value per share...

  • Page 68
    ... business combination transactions. At December 31, 2018, each outstanding share of preferred stock would be convertible into approximately 0.39 shares of common stock as a result of the 6% annual increase in the conversion value per share beginning in June 2003. As of December 31, 2002, the Company...

  • Page 69
    ... grant to purchase EarthLink common stock under the Company's stock option plans, and 5.3 million were available for grant under the stock options plans as of December 31, 2002. Warrants The Company has historically issued to certain members of its Board of Directors, customers, consultants, lessors...

  • Page 70
    ...$ Employee Stock Purchase Plan During the year ended December 31, 2002, the Company adopted the EarthLink, Inc. Employee Stock Purchase Plan (the "ESPP"). Under the terms of the ESPP, eligible employees may have up to 15% of eligible compensation deducted from their pay to purchase EarthLink common...

  • Page 71
    ...the fair value of stock options used to compute pro forma net loss disclosures is the estimated fair value at the date of grant using the Black-Scholes option-pricing model with the following assumptions: Year Ended December 31, 2000 2001 2002 Annual dividends Expected volatility Risk free interest...

  • Page 72
    ...free merger with OneMain in September 2000, the Company acquired $32.9 million of additional deferred tax liabilities primarily related to the customer base and related intangibles. The Company... 2002, the Company had net operating loss carryforwards for state income tax purposes totaling ...

  • Page 73
    ... at a discount, and providing access to EarthLink's F-35 customer base at EarthLink's normal rates. Amounts payable at December 31, 2001 and 2002 under such agreements are included in accrued communications costs in Note 7. Minimum commitments under non-cancelable network service agreements are as...

  • Page 74
    ... the network services agreement that was implemented in connection with the Strategic Alliance with Sprint, EarthLink paid Sprint approximately $53.6 million, $75.2 million and $75.4 million during the years ended December 31, 2000, 2001 and 2002, respectively. The aggregate amount due to Sprint was...

  • Page 75
    ... centers in Atlanta, Georgia; Harrisburg, Pennsylvania; and Roseville, California as well as to existing outsourced call center providers. The Company anticipates the plan will result in a net reduction of approximately 920 employees, primarily customer support personnel. In connection with the plan...

  • Page 76
    ..., Inc. (predecessor to EarthLink, Inc.)-File No. 333-94177). - Amended and Restated Registration Rights Agreement, dated as of February 8, 2001, with Sprint Corporation and Sprint Communications Company L.P. (incorporated by reference to Exhibit 10.9 of EarthLink, Inc.'s Report on Form 10-K for the...

  • Page 77
    .... Employee Stock Purchase Plan (incorporated by reference to Exhibit 99.1 of EarthLink, Inc.'s Registration Statement on Form S-8-File No. 333- 83870). - (a) Netscape Communications Corporation Internet Service Provider Navigator Distribution Agreement, dated May 31, 1996, between EarthLink Network...

  • Page 78
    ...And Supplementary Data Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure PART III Item 10. Directors and Executive Officers of the Registrant Item 11. Executive Compensation Item 12. Security Ownership of Certain Beneficial Owners and Management and Related...

  • Page 79
    ...-OXLEY ACT OF 2002 In connection with the Annual Report on Form 10-K of EarthLink, Inc. (the "Company") for the period ending December 31, 2002 as filed with the Securities and Exchange Commission on the date hereof (the "Report"), I, Charles G. Betty, Chief Executive Officer of the Company, certify...

  • Page 80
    ... ACT OF 2002 In connection with the Annual Report on Form 10-K of EarthLink, Inc. (the "Company") for the period ending December 31, 2002 as filed with the Securities and Exchange Commission on the date hereof (the "Report"), I, Lee Adrean, Chief Financial Officer of the Company, certify, pursuant...