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Audible, Inc. (ADBL)

Q1 2006 Earnings Conference Call

May 9, 2006 5:00 p.m. EST

Executives

Donald R. Katz - Chairman and CEO

Andrew Kaplan - Chief Financial Officer

David A. Joseph - Vice President, Corporate Communications & Strategy

Analysts

Mark Argento - Craig-Hallum Capital

Barton Crockett - JP Morgan

Darren Aftahi - ThinkEquity

Mark Mahaney - Citigroup Smith Barney

Richard Fetyko - Merriman Curhan Ford & Co.

Michael Olsen - Piper Jaffray

Sameet Sinha - Kaufman Brothers

George Mihalos - Gilford Securities

Operator

Good day, and welcome to today’s First Quarter Earnings Conference call. Today’s call is being recorded. For opening remarks and introductions, I would like to turn the call over to Mr. David Joseph, Vice President of Corporate Communications and Strategy. Please go ahead, sir.

David Joseph

Thank you. Good afternoon, and thank you and welcome to Audible’s earnings release conference call for the 2006 first quarter. Joining me are Don Katz, Chairman and CEO, and Andy Kaplan, Chief Financial Officer. This conference call is being broadcast on the Internet and is available through the investor relations section of the Audible website. It is also being recorded and will be pod cast. To sign up for the pod cast of this and future earnings announcements through Audible Wordcast, you can go to the IR section of our website and click into webcasts and presentations.

Before we begin, I would like to take this opportunity to remind you that during the course of this conference call, we may discuss some non-GAAP measures in talking about our company’s performance. You can find the reconciliation of those measures, the GAAP measures in the tables of our earnings release. In addition, management may make forward-looking statements regarding matters that involve risk and uncertainty, including those relating to the company’s ability to grow its business and customer base. Our actual financial results could differ materially from those discussed during this conference call. Information about factors that could affect our operating results is included under the captions risk factors that may affect results of operations in financial conditions and management discussions and analysis of financial condition and results of operations in our annual report on form 10K and quarterly reports on form 10Q, copies of which may be obtained by visiting the investor relations section of our website.

We will being today’s call with Don providing an overview of our business, followed by Andy who will provide greater detail on our financial performance before Don returns to wrap things up. Following Don’s discussion, we will be happy to respond to your questions. Now, over to Don.

Donald Katz

Thanks, Dave, and welcome to today’s conference call, everybody. We are here to tell you about a start to 2006 characterized by strong revenue growth and new member additions, as well as lower churn and lower costs to acquire new customers. We have focused intently on customer experience upgrades on a variety of levels in the wake of rolling out our new website, installing new web infrastructure, and offering listeners new and more flexible membership plans during the latter days of 2005.

The new plans, as with our growth initiatives abroad, our wireless platform development, our broadening of our market definitions for our education effort, and a focus on short-term entertainment content, are prominent aspects of our intense commitment to innovation, operational agility, and to the long-term growth and profitability of our business.

Q1 was the time to test and optimize the new Audible listener plan, and although we are still in the early days of the new progress, we are very enthusiastic about what we are seeing. The purchasing and listening behaviors of the new customers we acquiring and introducing to the habit of audible service via the new plans is heartening and also reflected in the strength we saw across key operating metrics, and in the record revenue we generated despite new revenue recognition policies.

One of the things we want to accomplish during this call is to convey some of the ways we are looking at upgrading and optimizing the quality and utility of the numbers generated in response to our new programs. These indicators will come together as we move through the first year under the new plans, as far more transparency for those who follow our business.

We are intent on bringing our internal and external reporting of important operating metrics up to a level that we feel is best in class, so we have gone back to scrub, re-scrub and more clearly define certain operating metrics that we also disclose to the public on a periodic basis.

Our goal is to ensure that the internal metrics we look at on a daily basis mirror the same metrics we disclose to you periodically. So here are a few details related to the significant progress we saw during the quarter.

First, new AudibleListeners acquired during the quarter totaled 79,000, reflecting growth of 46% year on year and 26% sequentially. We ended the quarter with 279,000 total AudibleListener members versus 245,000 at the end of 2005, and 186,000 at the end of Q1 2005, a percentage increase of 50% year on year and 14% sequentially.

So please take a moment to look at the detailed table at the back of the quarter’s earnings press release. It outlines and defines some revised policies related to customer data and how these revisions are reflected in the metrics we publicly disclose. You will see that none of these changes are material, but we do want you to be aware of our efforts to be exceedingly clear as to how we define an AudibleListener member, how we track how long they remain with us, as well as the costs associated with acquiring new members.

When you look at the chart, you will note that these upgraded metrics show that even as we saw very strong growth in new AudibleListeners in Q1 ’06, we also saw churn decline for the third quarter in a row by 20 basis points, from 4.8% to 4.6%. This was partly expected, as we saw a strong growth in AudibleListeners coming to us through the new $9.95 annual plan, but we also saw clear improvements in retention among our uncommitted AudibleListener gold and platinum members, who pay us from month to month and can cancel their memberships at any time.

During the first quarter, we saw that our gold and platinum members spent significant dollars over their monthly plan fees during the quarter. Gold and platinum members spent 16% more than their monthly fee on average, and our $9.95 customers purchased more audio programs than we expected, reflecting strong acceptance to the enhanced value proposition of our new plans.

Average revenue per use, as we told you to expect, was slightly down sequentially in light of the new revenue recognition associated with our AudibleListener membership plans and lower-cost entry plan, but we expect the lowered barriers to membership to serve our business well over time, due to increased access to membership, migration to higher level plans, lower subscriber acquisition costs, and longer-life customers in general.

As I noted, the success we saw in acquisition and retention in Q1 resulted in record net revenue of $19.7 million, reflecting year on year and sequential growth of 53% and 8% respectively. As was discussed in our last call, the total deferred revenue on our balance sheet is becoming a far more important metric through which to view our progress as we now recognize revenue as credits consumed or, in some cases, along a schedule that is slower than the pace of downloads.

As of the end of Q1, deferred revenue totaled $8.6 million, more than double the deferred revenue in the prior year period. The change from the more straight-line revenue recognition for the old plan is highlighted by the fact that the change in deferred revenue for the first quarter of 2005 versus fourth quarter of 2004 was about $100,000. During the first quarter of 2006, the quarter-over-quarter increase was just over $2.1 million.

When we look at our metrics by the day, we focus on the cash coming into the business, and we recommend that our investors do the same. Andy will talk about the expense side of the business and our operating loss during the first quarter, but I will recommend here that you keep in mind the disparity between unrecognized revenue and the upfront cost of acquiring new customers and serving those customers accounts for the largest portion of the operating overhead and loss we are reporting this quarter.

We still diminished our operating loss, as we said we would during the last call, but generally understanding the accounting changes related to the revenue and cost aspects of the new plans is important in understanding the character of our progress.

Bottom line, I want to reiterate here that we expect profitability to improve as we move through 2006, and for the company to be profitable for the full year.

Before I turn it over to Andy, I want to touch on a few business highlights from the quarter. As I mentioned earlier, we are very focused on all aspects of the customer experience. On February 12th, all Audible websites here and abroad were migrated to our new IT infrastructure. Our page download times have improved by 20%, and our downloads are much faster, while throughput is up by 14% since the beginning of the year.

Customer satisfaction levels are up significantly over the course of the quarter, and average telephone hold times in the customer service department have shrunk dramatically. Email response metrics have improved by some 80% since the beginning of the year. As I will note after Andy’s discussion, the entire company now shares performance goals, and part of every employee’s compensation is tied to customer satisfaction measures.

On the all-important content front, we now have around 100,000 hours of first-rate listening available at Audible.com. We added more than 1200 new titles during the first quarter and signed 27 new and renewed content partners. Over 60% of our content relationships continue to be exclusive, multi-year partnerships. During Q1, we established exclusive relationships with Forbes and Harvard Business Review, and added new ones with the Atlantic Monthly and the Ricky Gervais show, the popular short-form program from the British comedian who created The Office and HBO’s Extras.

The first season of The Ricky Gervais Show was a free pod cast, and the second season was a paid pod cast. The program generated a ton of press here and in the U.K., including a front-page New York Times art section review, and significant sales. At one point, various episodes of the show occupied 5 of the top 10 selling albums at iTunes U.K.

Our Audible education initiative continues to make great progress. Our jointly developed higher education and audio study guide series developed under the brand name, Vango Notes with Pearson Higher Education, is rolling out via Pearson’s huge channel sales force in advantage with the academic year in the fall.

The early products are elegant audio programs that can stand alone as good listening beyond their obvious learning utility when used with the top-selling textbooks. We are also conducting tests of the learning and literacy advantages of our audio in the K-12 and higher education classroom environments in New York, Philadelphia, and Arizona. We are very enthusiastic about products and services in enhanced learning through the Audible audio system.

On the Audible ready device front, 11 new Audible ready devices were shipped to stores during Q1. We currently count 202 compatible Audible digital devices in the market, with more on the way.

We also advanced our wireless platform development and related work with handset and OS companies during the quarter. We hit version 1 status for the Pocket PC, Smartphone and Simian implementations, and are working on a Java implementation focused on feature set phones from various manufacturers. We continue to see 2007 as the lift-off point for wireless delivery via Audible Air.

With that, I will turn it over to Andy.

Andrew Kaplan

Thanks, Don, and hello, everybody. As Don noted, total revenue in Q1 was $19.7 million, up 53% year on year and up 7.9% over the fourth quarter of 2005. Fueling the growth in revenue was strong acquisition of AudibleListener members, lower churn, and strong growth of Audible spoken audio sales at the Apple iTunes Music Store.

During the first quarter of 2006, we added 79,000 new AudibleListener members, bringing total AudibleListener membership to 279,000, up by 34,000 from year-end 2005.

As Don also mentioned, it is important to remember that under our new AudibleListener plans, while customers continue to pay up-front on both annual and monthly plans, because we offer our customers the flexibility of using their audio credits on their own schedule, revenue recognition is delayed until the audio credits are used. This unrecognized revenue is included in the deferred revenue account on the balance sheet. The increase in deferred revenue of $2 million from year-end 2005 to March 31, 2006, is due primarily to higher AudibleListener membership and the related increase in pre-paid audio credits that our customers will be using in the months ahead. As these credits are used, the related revenue will begin to flow into our income statement.

Revenue from sales at the Apple iTunes Music Store of $4.4 million was up 32% from the fourth quarter of 2005.

Turning to operating expenses, royalty expense in the first quarter was $8 million, or 41% of consumer content revenue versus 40% in the fourth quarter of 2005. Total royalty expense as a percentage of revenue is heavily influenced by the mix of revenue earned from Audible customers versus through Apple iTunes, which has a higher contribution margin than average, but a lower gross margin.

Revenue from Apple was 23% of total content and services revenue compared to 19% in the fourth quarter of 2005. But our cost of content is also influenced by product mix, pricing, and customer mix. Because our business framework excludes inventory carrying costs, or inventory obsolescence, our pricing, promotion and merchandising initiatives are targeted towards maximizing absolute gross profit dollars. So overall, if you were to exclude Apple from our P&L, our gross margin would be closer to 70% than 60%.

Looking at operations, continued strengthening of our customer service capabilities has resulted in much quicker customer response time versus Q4 of 2005, and based upon our ongoing survey data, significantly higher customer satisfaction. The cost of these initiatives are reflected in higher operations expense.

In technology and development, depreciation expense related to our upgraded site capacity and amortization of internal use software improvements resulted in higher expense during the quarter.

In marketing, Audible’s cost per new AudibleListener in the first quarter of 2006 was $52, down sharply from the fourth quarter of 2005, and at its lowest level since Q1 of 2005. Improved execution and customer response to our new marketing initiatives were the primary contributors to this significant decline.

G&A is up in the first quarter of 2006, although excluding stock-based compensation, G&A was flat with Q4 of 2005.

As we note in our press release, in Q1 we adopted the new accounting standards, FAS 123R, which resulted in a new, non-cash charge in our P&L related to stock-based compensation. The stock-based compensation charge in Q1 was $1.1 million versus $420,000 in Q4 of 2005.

As a result, we have done two new things during this quarter. One, we have provided detail of the breakdown of this charge in our earnings release, to provide you with a clear understanding as to where these expenses lie in our P&L, and we have begun to provide non-GAAP operating income, net income, and earnings per share, which excludes the impact of stock-based compensation, which we believe provides a clearer picture of the company’s financial performance.

So on a non-GAAP basis, which excludes these expenses and all other expenses related to stock-based compensation, our operating loss was $2.6 million in Q1, reflecting a $650,000 improvement from Q4 2005.

In Q1, interest income increased to $660,000, reflecting earnings on our $60 million cash and cash equivalence balance, and with that, our net loss for the quarter was $3 million, or $0.12 per diluted share on a GAAP basis. On a non-GAAP basis, our net loss in Q1 was $1.9 million, or $0.08 per diluted share.

Operating cash flow in the first quarter of 2006 was a negative $3.6 million. This negative cash flow was driven by our net loss, a reduction in payables, an increase in prepaid maintenance, partially offset by an increase in deferred revenue. In Q1, we spent about $5 million on a combination of multi-year e-commerce site license upgrades, including two years of prepaid maintenance for our e-commerce site. This was reflected in the improvements we made to Audible’s technology infrastructure and site performance during the quarter.

I also want to note here that we plan to file form 12B25 tomorrow. That will give us five additional days to complete our 10Q. We are still working with our auditors on a few details on FAS 123R accounting, and the final review of our revenue recognition related to our new membership plans. We do not expect any material variance from the numbers we are conveying today.

With that, I will turn it back over to Don.

Donald Katz

Thanks, Andy. Before opening this up to questions, I want to convey my pride in our company’s efforts to execute elements of change designed to ensure a bright future. Everyone here has worked hard over the past six months to install new systems, processes, measurements, and infrastructure that will allow us to rise to new levels of size and profitability.

As we move closer to gaining our one-millionth paying Audible.com customer since launching our service, I believe we have retained an essential culture of innovation. We are intent on leading this vibrant new media category we have worked to invent. We invented this game, as our COO Glen Rogers likes to say, and we sure as heck intend to win it.

I think it is worth mentioning to investors that we spent time more closely aligning the goals of all our employees with our effort to better serve our customers and shareholders. Each employee’s compensation is now firmly tethered to internal goals. Bonuses, raise, and long-term equity based compensation for employees at all levels are now linked to four metrics. The first is revenue, the second is profit, the third is the growth of our net subscriber base, which of course measures the combination of new customer additions and their propensity to cancel subscriptions, and finally, as I noted earlier, the fourth measure is customer satisfaction, which is tracked by a formula drawn from Six Sigma quality tracking and other metrics. The purpose of this clear and unified calibration of our performance is to pull all of us -- employees and shareholders alike -- into the same boat.

A friend recently drew my attention to Warren Buffett’s Annual Thoughts For Investors. In his last shareholder letter, Buffett wrote that “When short-term and long-term focus conflict, a company that focuses on the short-term, to the detriment of customer satisfaction, brand strength, and competitive advantage will not succeed. If you choose that path,” Buffett wrote, and I am quoting here, “no amount of brilliance will overcome the damage that has been inflicted.”

We are working here at Audible to fundamentally redefine the distribution, consumption and economics of the vast marketplace in words. We intend to fill the hundreds of millions of hours per week that people cannot read because they are driving or exercising with incomparable value. We are here to seize the huge business opportunity forming in front of us, and we intend to do this to the mid- and long-term advantage of our investors.

The first quarter of 2006 was another important period of progress for Audible, and we only expect more progress and more measurable success from here. With that, we will open up the questions.

Question-and-Answer Session

Operator

Thank you. (Operator Instructions)

Our first question comes from Mark Argento with Craig-Hallum Capital.

Mark Argento - Craig-Hallum Capital

Thank you. I apologize, I am losing my voice so hopefully I won’t go out here in the middle of my question, but a few questions for you guys. Can you talk, now that you have had the new program in place in terms of the rollover credits, can you talk a little bit of the trends you have seen in terms of take-rates on those products for the different-tiered level, the platinum, the gold? What are you seeing? Anything troubling there? Anything encouraging there? That will be my first question.

David Joseph

So far, it is still fairly early in the game, but from what we have seen so far in Q1, we were fairly pleased. We saw some good acquisition and we certainly saw improved retention, which we are pretty happy about, which Don alluded to in his previous comments.

I would probably say, breaking it down a little bit more, passports are consuming a little bit more than we had expected, certainly on a unit basis. When you look at the gold’s and the platinum’s, we are fairly pleased with their consumption as well, especially the annual plans, where we are seeing some better consumption than we had actually expected.

Overall, it is a little better than where we were with our legacy plans, so we are fairly pleased right now.

Donald Katz

One thing I want to add is that while the consumption fetters now put our merchants’ feet to the fire because they can see how they are doing in terms of selling, but when people do rollover credits, we should not forget that they pretty much prophylactic on churn, because people are not taking for whatever reason a few months out, not using the service means that you lose those credits.

David Joseph

By the way, when I say passports, I mean $9.95 plan. Sorry about that. That’s an internal term we use here.

Mark Argento - Craig-Hallum Capital

Talking about the $9.95 plan a little bit more specifically, clearly churn is coming down. Could you quantify, I know you guys do not break out the $9.95 listeners within the AudibleListener base, but just so we have a little bit better apples to apples on the churn and ARPU, can you quantify what impacts those have had on those businesses, the reduction in churn now because these guys are locked in for a year, and in particular on ARPU?

Donald Katz

I tried to mention this directionally, that there are two positives. I know the assumption, we’re not going to break it out very specifically, but there is clearly a mathematical effect of having many more people who are here for a year that is very positive on churn, but we are seeing over and above that -- much lower cancellation rates on the month-to-month gold and platinum. We have a pretty good internal way of tracking that, because we still have legacy customers on the old premium and basic plans. So, so far, so good.

Mark Argento - Craig-Hallum Capital

In terms of the revenue, $19.7 million, $4.4 million of it was Apple. The rest of the revenue in terms of A La Carte, the Amazon channel -- where does the rest of the revenue come in? How much of the revenue is pure subscription revenue?

Andrew Kaplan

By far, the majority of our revenue continues to be subscription revenue, but with the advent of our new plans, we no longer break out the pieces of subscription versus non-subscription.

Mark Argento - Craig-Hallum Capital

So if I wanted to get to an ARPU number for your subscriber base, that is a number that is going to be elusive for us?

Andrew Kaplan

I think the best way to get it is to take our total content services revenue, back out Apple, and divide it by the average AudibleListeners for the period.

Mark Argento - Craig-Hallum Capital

Fair enough. Last question for you, in terms of the margin on the deferred revenue that you are putting on the balance sheet, how much costs have been put against the P&L in the quarter for that deferred revenue? I.E., is that 70% operating margin revenue on the balance sheet now? Are you recognizing all the customer acquisition costs, related costs against that except for content?

Andrew Kaplan

You bet. You know, historically, we have treated marketing expenses as a period expense. We continue to do that, so when our customers use those credits, the gross profit will drop to the bottom line.

Mark Argento - Craig-Hallum Capital

Is there a six-month true-up if they are not taking the credits down? When can you accelerate it and when can you pull that back on that income statement?

Andrew Kaplan

Well, customers can bank up to six months of credits, but you can be sure that every day of the week, we do as much as we can to encourage people to continue listening and to use their credits.

Mark Argento - Craig-Hallum Capital

Thank you.

Operator

Once again, that is star, one if you would like to ask a question. We will now go to Barton Crockett with JP Morgan.

Barton Crockett - JP Morgan

Thank you very much. I was wondering if you might be able to break down a little bit more precisely, the $2.1 million contribution from deferred revenue. How much of that specifically came from members who gave you cash but from whom you couldn’t record revenues because they rolled over a credit? Could you give us an color on the percent of AudibleListeners in the period who deferred a credit, some color on the level of deferral and the uptake there, and on the potential ability of what you see in this quarter, maybe to future periods?

Then, in terms of the new metric restatement that you are giving, could you give us a little bit more color on what exactly you have changed in the new calculation versus the old calculation? Maybe I missed it, but in the release, for instance, the churn verbiage seems the same, and in both, the numbers are different. I am just wondering what exactly changed in the way you are calculating this?

Andrew Kaplan

You know, the increase in deferred revenue is really from the people that we have recruited this quarter, that is new AL’s that have not used all of the book credits that they purchases. So for instance, if we processed somebody that was on an annual program and bought 24 book credits, they might have only used a few of them this quarter, so the balance are still in the deferred revenue line.

Similarly, for all the Everest customers or the new AudibleListeners that we recruited in December of ’05, to the extent they haven’t used all of the audio credits we issued to them, or that they purchased from us, that also caused an increase in deferred revenue in this quarter.

So on balance, what is driving the increase in deferred revenue is the cash we get from our customers less the credits that they are using.

Barton Crockett - JP Morgan

Okay, but to be clear on that, did almost everyone that you have recruited in this quarter not use up all their credits? Can you give us some color on the percentage of uptake here?

Andrew Kaplan

We will not give you any color on the percentage, but what I will say is we have some customers that use their credits well ahead of the normal pace. For instance, customers that are in a an annual plan and may listen to four books a month. By the same token, we have customers that are in the two-book plan that may only use one book a month, or one-and-a-half books a month.

Donald Katz

Also note that I mentioned that there is still a significant buying over plan element to it, which is really interesting in light of the fact that there is more flexibility on the credit side. So I think that indicates that there are people who are clearly topping off their credit usage and going over it, as well as some people who, for whatever reason, are not using it.

Barton Crockett - JP Morgan

Okay.

David Joseph

Barton, on your second point, we are in the midst right now of enhancing our reporting, both internally and externally, and obviously the focus is making sure that we are reporting what we are looking at internally and what we disclose externally are the same, and so, basically what you are seeing in the metrics there is us just taking out, refining our policies as to what an AudibleListener is, what a new AudibleListener is, and I can give you an example. For example, somebody who might cancel a plan in one day and then take another plan later on that day, the policy used to be to treat them as a cancel and then a net add. Right now, we actually now treat them as just a member, so there is no movement, no addition of churn, no addition to net adds. We think that is just a more appropriate policy, and that is what you are seeing reflected in the numbers.

There are a couple of other policies that we refined as well, but overall the key point here is just to make sure that what we are promoting or putting out there publicly is accurate, and we think that these numbers are accurate and that they are rock-solid.

So churn has not changed. It is really just looking at the absolute numbers and make sure that they are an effective reflection of what our AudibleListeners are doing today and where they are today.

Barton Crockett - JP Morgan

Okay, I will have to leave it there. Thank you very much.

Operator

We will now go to Darren Aftahi with ThinkEquity.

Darren Aftahi - ThinkEquity

Just a couple of questions. One, if you scale Apple revenue and it gets more and more a component of your business going forward, can you talk a little bit about where exactly the leverage is, given the lower gross margin, of your confidence in getting the profitability for the full year?

Donald Katz

Remember that it might appear to be lower gross margin in terms of content cost line, but it is higher contribution margin because of the character of the other cost elements in the revenue stream.

Darren Aftahi - ThinkEquity

Okay. My second question would be, are we going to see anything on the carrier side this year as far as wireless or is it just going to be pure integration on the operating side and the handset?

Donald Katz

We will keep you posted on that, but we do have a relationship with Sprint, and there is actually more Sprint Audible-ready phones coming out regularly, and we have some pretty exciting stuff with Sony Erickson phones, particularly in Europe and Asia. But in terms of the carrier relationships and the carrier business models and the like, I think we will just have to keep you posted. You can be assured that we are in consistent dialog with all of them.

Darren Aftahi - ThinkEquity

Great, thank you.

Operator

We will now go to Mark Mahaney with Citigroup Smith Barney.

Mark Mahaney - Citigroup Smith Barney

Thank you. My first question, I would like to dive a little bit into why customer satisfaction is rising and why people are buying more. It sounds like improvements in customer service. It sounds like improvements in site usability. It sounds like it could be improvements in selection. Is the answer simply all of the above, or would you single out one or two things?

I would also ask how sustainable is that going forward? Are you already seeing those improvements in customer satisfaction and usage continue beyond just the March quarter into the June quarter as well?

Donald Katz

We have seen it continue, and it is really all of the above, and it’s a combination, and to each his own in terms of the perception of the value of the service, but clearly if the website is fast, and the selection is great, and the customization elements are beginning to be even more germane to an individual listener, that is considered a huge positive. We can’t forget the fact that the end user experience for us ultimately is the audio, and it just keeps getting better, and it’s consistently strong.

The other thing as customer service, obviously if you are a busy person and for whatever reason you need us, how quickly we pick up the phone is just a big deal, because it is a product for busy people. So to answer your question about the continuing performance elements, the 3-minute average hold time at the end of 2005 last month was down to 16 seconds. So we are pushing this pretty hard, because the fact of the matter is it’s a service, and we need to have a service environment.

Mark Mahaney - Citigroup Smith Barney

Just to clarify your comments, Don, about profitability for the year. Could you just again clarify what exactly you mean by that? Are we talking GAAP profitability, operating income profitability, non-GAAP operating income profitability -- what is the specific goal you want for the year?

Andrew Kaplan

We expect to move towards profitability in the year and to be profitable for the full year, excluding stock-compensation charges.

Mark Mahaney - Citigroup Smith Barney

Okay. Final question, back on the iPod revenue, is there a level that you want to have in terms of the revenue contribution from iPod? I guess at some point, you know, 50% of your revenue coming from iPod would probably not be a great thing. Is there a zone or a range in which you want to keep that revenue? You want that revenue to grow, obviously, but you also want it to grow on your core site. How should we think about that? How should we think about managing that risk, that over-dependence, if you will, on the iPod channel, or do you see that as a risk?

Donald Katz

It is hard for me to see it as a risk, because of the character of the relationship and the inter-dependencies of the company, because it has technology elements embedded in the iPod, and I think you were referring more to our iTunes revenue. The fact of the matter is they are growing like crazy, and we are actually seeing the results of it, particularly in Q1, because they have a seasonal uptake effect in Q1 having to do with all the people who get devices around Christmas, and clearly they are just rocking.

Do not forget that we have a pretty significant level of branding at iTunes, and everyone who listens to a piece of content there knows that Audible.com has provided it, so there is a rub-off that is pretty significant in terms of awareness building that is also a positive.

So you know, the core site and all of the satellite sites and the international sites and the like, still dominates the numbers of downloads. There is a pretty clear distinction between the membership oriented, service oriented element of our business versus the a la carte buying at Apple.

Right now, it is a pretty powerful symbiosis in every way, to say nothing of the fact that a lot of the Audible.com customers obviously are using iPod. So I guess in any partnership, there are elements of risk but so are there elements of risk in any non-partnership business environment. Right now, this feels like the right thing to do, and I do not really have a particular revenue number in mind where it is too risky.

Mark Mahaney - Citigroup Smith Barney

Thank you very much.

Operator

Next we have Richard Fetyko with Merriman Curhan Ford & Co.

Richard Fetyko - Merriman Curhan Ford & Co.

Just curious about your marketing and customer acquisition channels, what has changed, and what do you see as working. Also, the entry-level $9.95 product, if you are seeing any conversions and upgrades to the higher end plans that you offer at this point?

Donald Katz

Our channels, Richard, we continue to have a broad array of variable marketing channels from the boxes people open up where there are device offers to our various other kinds of marketing merchandising partnerships, our affiliate network. I think we are getting much better at using search and search terms. We certainly upgraded our natural search recently.

The character of our service using the BroadVision platform was not actually exposed to natural search in a powerful way, and that changed significantly through development efforts here, so we expect a lot more from that channel. So we have a long list of decent single-digit percentages of the AudibleListener mix at any given point in time, which is the way it should be, because you can modulate spending as you go forward.

Our boutique network is really a pretty strong way to get noticed in high-traffic environments, our partnerships with Bookspan, where we have boutiques in all the big book club environments, and XM Satellite and others are great ways to acquire new customers.

Dave is going to answer the other part of your question.

David Joseph

On the migration front, just keep in mind that it is still very early days for us. We only launched back in December, and even for the first quarter, you still have roughly two-thirds of our customers who have only been using this service at that $9.95 level for one or two months. So we do not want to immediately start pegging these guys with emails and encouraging them to migrate before they really start to get a taste for the service.

So in terms of migration up, there has been some but it is nothing to write home about just yet. But going forward, we are certainly focused on acquiring people through that lower barrier of entry, and then driving the activity because by the way, if we get those $9.95’ers to buy 10 to 20 books a year, it is not necessarily a bad thing for us. But then also, up-sell them as the opportunity presents itself and as we get a little bit more thoughtful about that throughout the rest of the year, so you should see our migration increase throughout the rest of the year.

Richard Fetyko - Merriman Curhan Ford & Co.

Thanks, and just a follow-up, churn expectations, has anything changed? Should we expect any changes in churn going forward off of the levels reported in the first quarter? Thank you.

Donald Katz

Just really quickly, we are pretty happy with where churn has been trending over the last couple of quarters, but at this point, we are not going to provide guidance for the second quarter.

David Joseph

Next question.

Operator

(Operator Instructions)

We will go now to Gene Munster with Piper Jaffray.

Michael Olsen - Piper Jaffray

Hello, it’s actually Michael Olsen here. I am just wondering how you guys are feeling about competition right now. Is Media Bay on the radar anymore, less than they were at this time last year? Any thoughts on Amazon and what they may be doing?

Donald Katz

No, it sounds like Media Bay is still doing some interesting things, and we are evermore interested in the competitive landscape as others rise up, so we certainly keep an eye on them.

As far as Amazon is concerned, at this point, they are a partner. It’s publicly unclear what their strategy is on digital media, and we are just going to watch and wait like everybody else.

Michael Olsen - Piper Jaffray

Then I just want to make sure I heard right on something. Did you say that 67% of content on the site is now exclusive content?

Donald Katz

No, I did not. It is about 63%. I said more than 60%, it’s 63%, and 63% of the deals that generate the content, it tracks directionally with the title comp, but it is really more the relationships that we are talking about. I think it is up to 318 different content partnerships right now.

Michael Olsen - Piper Jaffray

Thank you.

David Joseph

Operator, are there any more questions?

Operator

Yes, we do have a question from Sameet Sinha with Kaufman Brothers.

Sameet Sinha - Kaufman Brothers

Good evening. Just elaborating on the marketing question that Richard had asked earlier, what percentage of your subs came from your one-month free plan, which is some of the more expensive, free Shuffles, or $100 off promos?

Donald Katz

Sameet, are you talking about our free trial programs?

Sameet Sinha - Kaufman Brothers

That is right. I mean the new subscribers that came on, how many came on using the free trial programs?

Donald Katz

That is not a metric that we really break out anymore, primarily because it is not as meaningful as it used to be. I mean, we use free trial programs still, opportunistically. But we are finding that the new plans that we developed, especially the $9.95, is an effective and efficient method of acquiring customers.

Sameet Sinha - Kaufman Brothers

Okay, but would you say that both of them are balanced? There were times in the last few quarters where at some point, one was more powerful than the other. So you think they have balanced out?

Donald Katz

I think if I could just read into what you are saying, Sameet, I think before the new plans were launched, people looked for two key dynamics to find out where churn was going. If there were a lot of trials, assuming churn was going up, and if there were a lot of commitments, meaning people who took a free device or took $100 off, then potentially churn was going down because of the commitment.

We have put so many more dynamics in play with the new plans having to do with addressing some of the real reasons for churn was rollover credits, these longer-term plans which offer access to the programs through the $9.95 annual and the like, so now it is going to be a consistent mix of dynamics that create whether there is churn or not. So I think it has just become less simple.

Sameet Sinha - Kaufman Brothers

Great. Second question is on the deal with Apple. Can you talk about when it comes up for renewal, and any discussions recently or otherwise that you have had with them for resigning the deal?

Donald Katz

No, I am not going to talk about any discussions, but it is in the fall of 2007.

Sameet Sinha - Kaufman Brothers

Okay. When do you think you could start giving guidance, potentially, when you know all the metrics that you are generating?

Donald Katz

The way we are looking at it right now, Sameet, is that we do not want to put anything out there publicly until we really get a chance to see or observe our customer behavior a little bit more in these new plans. This is very new to us as it is for our customers. We think it is innovative and we seem to be seeing our customers appreciating the value proposition, but we just need to observe it for a little longer.

Sameet Sinha - Kaufman Brothers

Great. Thank you very much.

Operator

We will now go to George Mihalos with Gilford Securities.

George Mihalos - Gilford Securities

Good evening. I was hoping you could talk a little bit about your international business and some trends you are seeing there, and also with respect to your buy-back program, if you could update us with what is going on there. It does not look like you were too active in the first quarter.

Donald Katz

Internationally, U.K. continues to make good progress. Obviously the Ricky Gervais phenomena was a much bigger deal in the U.K. than it was in the U.S., and they benefited from that. We also are pretty excited by the content acquisition front over there. I think they have 26 on the ground partnerships, which of course benefits us worldwide because it is in English and we can sell it here as well as in other English-speaking territories, so that has been going well.

The Germany and the French operations also seem to be doing well. The German operation is consistently innovative, and I think as I mentioned last call, they are also consistently seeing competitors. I think there is over a dozen at this point, and yet their growth and their market share is very impressive. That is a JV structure, but still it’s a wonderful kind of proving ground in a country that had no audiobook industry, that has just basically exploded with interest in spoken word, so it’s been pretty exciting in general.

The other part of it was on the stock question, we only actually had a few days of the window and purchased a pretty small amount of stock, but the board is still determined to opportunistically purchase stock if the value proposition seems like the right thing to do.

George Mihalos - Gilford Securities

Thank you.

Operator

That concludes today’s question and answer session. Mr. Katz, I will turn the conference back over to you for any additional or closing remarks.

Donald Katz

I just wanted to say that I appreciate everyone joining us. It is still more than exciting to be here at Audible and we are pretty jazzed up about what has been going on, so we will keep you posted. Thanks for joining us.

Operator

That does conclude today’s conference call. Once again, we thank you for your participation. You may now disconnect.

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Source: Audible, Inc. Q1 2006 Earnings Conference Call (ADBL)
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