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Audible, Inc. (ADBL)

Q2 2006 Earnings Conference Call

July 27, 2006 4:00 pm ET

Executives

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

Donald R. Katz - Chairman of the Board, Chief Executive Officer

Andrew P. Kaplan - Chief Financial Officer, Executive Vice President

Analysts

Mark Mahaney - Citigroup

Rob Malathey - JPMorgan Chase & Co.

Sameet Sinha - Kaufman Brothers, L.P.

Darren Aftahi - ThinkEquity Partners

Barton Crockett - JPMorgan Chase & Co.

Presentation

Operator

Good day, and welcome to today’s second quarter earnings conference call. Today's call is being recorded. For opening remarks and introductions, I'd like to turn the call over to Mr. David A. Joseph, Vice President of Corporate Communications and Strategy. Please go ahead, sir.

David A. Joseph

Thank you, operator. Good afternoon. This is David Joseph, Vice President of Corporate Communications and Strategy of Audible. Thank you and welcome to Audible's earnings release conference call for the 2006 second quarter. Joining me are Don Katz: Chairman and Chief Executive Officer, 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 for this and future earnings announcements through Audible Wordcast, you can go to the Investor Relations section of our website, and click into Web casts and Presentations.

Before we begin, I would like to take this opportunity to remind you that during the course of this conference call, we will discuss some non-GAAP measures that talk about our Company's performance. You can find the reconciliation of those measures to GAAP measures in the tables of our earnings release.

In addition, management may make forward-looking statements regarding matters that involve risks and uncertainties, including those relating to the Company's ability to growth, business and customer base. Our actual financial results could differ materially from those discussed in during this conference call.

Information about factors that could affect our operating results included under the caption risk factors that may affect results of operations and financial conditions and management's discussion and analysis of financial conditions and results of operations in our Annual Report on Form 10-K, and quarterly reports on Form 10-Q. Copies of which can be obtained by visiting the Investor Relations section of our website.

We will begin 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.

Don Katz

Thanks, Dave, and welcome to the conference call, everybody. Q2 provided an important quarter for Audible as we made substantial progress toward building an evermore data driven organization that is committed to profitable growth, cost management, and high quality operations and service levels. This was a quarter in which we began to see the benefit of constructing important foundation blocks that will support our journey to very strong growth, profitability and competitive advantage well into the future.

It's worth mentioning that the timing of this conference call is earlier than any of our previous calls. This improvement is a direct result of the systems and process improvements we've made. 2006 continues to be a very positive year of progress for Audible. On the surface, the character of our considerable progress may not be as immediately apparent in this quarter's financial statement, but we will call to your attention, the transitional steps that we have taken to better position Audible for the profitable growth we see coming in the near, mid, and long term future.

We saw tremendous progress on our work on Next Generation wireless distribution platforms, and with the launch of promising new partnership based membership plans in Q2. I'll let you know more about that in a few minutes.

Perhaps the most important step forward is that during the quarter we added new leadership talent, and critical operating function, most notably in marketing, merchandising, constant acquisition, and customer service. These new additions bring extensive experience to our team, particularly in the areas of data driven decision making. Our data and what it tells us, is a key advantage born of our history and our scale, and something we intend to exploit far more powerfully going forward.

It is important to note that the new teams were assembled late in the quarter, and caused us to hold back significant marketing spending, which in turn led to lower revenue and customer acquisition than we expected.

During the quarter, our net AudibleListener membership base increased to 309,000, reflecting 51% year-over-year increase. We also saw a decline in the turn rate, which was down 120 basis points quarter-over-quarter to 3.4%, and we saw a return to positive free cash flow in operating cash flow, which came in at $1.7 million, and $2 million, respectively. We improved the bottom line by $1.3 million. Related to this was a $7 decline in our cost for new customers.

A marketing spend being below plan in Q2 and significant seasonal slowness, hindered our ability to acquire new customers and generate revenue growth. Deferred revenue continued to increase and now sits at nearly $10 million, much of which we expect to recognize as very profitable revenue in the coming quarter.

As our partners in the publishing industry know well, Q2 is not a powerhouse quarter for major new content releases. Q2 Apple iTunes derived revenue was down as a revenue generator for us by 7% quarter-over-quarter, after a 32% lead between Q4 and Q1. Our title download rates at audible.com and via our distribution network that includes iTunes are to some degree dependent on a steady flow of new best sellers, and the unveiling of new listening innovations like last quarter's Ricky Gravis show.

In Q1, we had blockbuster releases by Stephen King, James Patterson, and Jonathan Kellerman, and Q1's movie driven sales In Cold Blood, Brokeback Mountain, and Narnia. Strong new audio sales also enabled strong new customer conversions, so we're very optimistic about a rebound from this Q2 new content slump in light of what's coming up in the second half of the year. I'll talk a bit about that in a moment.

Although Q2 was a quarter exhibiting slower than anticipated top line growth, it was also a quarter where we clearly demonstrated progress in effectively managing cost. Quarter-over-quarter expenses were down significantly, and we continued our focus on aligning our staffing levels to the requirements of a growing and profitable business.

Audible's quarter-end staffing level was 12% below the peak level experienced last year. As I noted, Q2 represents a transitional quarter for us, as we continue to move from one stage of growth to the next. Through this transition, we continue to expect a strong second half of 2006 in terms of both revenue and profitability. Efficiency and scalability has been enhanced significantly here at Audible and this will serve us well as we grow much larger.

I'll provide a few examples of developmental progress in a minute, but first, here are a few key operating results from the quarter. As I reported, new AudibleListeners acquired during the quarter totaled 65,000 reflecting growth of 25% year-over-year and a decline of 3% sequentially. In our view, even though Q2 new member additions have dipped versus Q1, in the past this was a weak performance primarily driven by three factors. First, as many of you probably know, there has been some broader softness in terms of new unique visitors to commerce and media websites during that second quarter. This exacerbated the usual post holiday season dip we've seen in the past.

Second, as I mentioned, the publishing industry witnessed a very quiet quarter as well with a short list of new titles and big hit releases. This was reflected in the fact that an unusual number of the titles of our top ten sales lists for Q2 were backlist, or older titles. One of the powerful things about the Audible way of serving consumers is that as our already vast library of content grows larger by the day, almost everything we offer is purchased every week, but the hot new titles are still very critical to Audible's success in any given period of time.

Third, and probably the biggest impact, was the conscious decision we made during the quarter to hold back nearly 1/4 of our planned marketing spend until the new leadership in marketing and merchandising came on board. This decision was reflected in our variable marketing spending, which declined by 28% quarter-over-quarter, and a cost for new AudibleListeners which declined from $52 in Q1 to $45 in Q2, but also reflected in our new AudibleListeners being down by 17% quarter-over-quarter.

The slowing of our new member acquisition rates and a general new content softness reflected in iTunes and audible.com sales also had its impact on revenue, which was up 25% year-over-year and down 3% quarter-over-quarter to $19.1 million. As I mentioned, we did see strong growth in total differed revenue, an increasingly important indicator for Audible. As of the end of Q2 '06, total deferred revenue was just under $10 million, up 15% quarter-over-quarter, and [234]% year-over-year.

It is important to keep in mind that the disparity between unrecognized revenue and the upfront cost we recognize in acquiring our customers and serving them continues to account for the largest portion of the operating overhead and loss we are reporting this quarter. Understanding the accounting changes related to the revenue and the profitability of the deferred revenue soon to be recognized on the P&L is important in understanding the character of our progress and the Company’s ability to be profitable for the year.

I want to reiterate once again, that we expect profitability to improve as we continue to move through the latter half of 2006, and for the Company to be profitable for the full year before accounting for stock based compensation expense. Our extreme confidence in our business, and our ability to achieve a very successful 2006 and more successful years after that, is connected to a quarter in which the right people, an all star team, in fact, fell into place.

Through our clear ability to leverage improvements and the customer experience, to the number and usability of current and future digital audio devices coming into the market with Audible technology onboard, to the very positive impact our new AudibleListener plans are having in the value proposition of the Audible service, and to our programmatic plans to continuously create new levels of consumer awareness of our audio service.

Before I turn it over to Andy for numbers, I want to touch on a few business highlights from the quarter. First, the UK operation saw 23% quarter-over-quarter revenue growth, net of our Apple iTunes UK revenue. Despite their big hit in Q1 2006 with Ricky Gervais show, we still expect much better things in the UK, but I do want to note that with the UK iTunes revenue included, we have hit our goal of having a cash flow positive operation in England, very quickly, I should add. These results obviously do not include the financial benefit of the English language content we source in the UK and distribute to English language listeners around the world.

On the content front, we now have more than 105,000 hours of world class listening available at audible.com in the form of over 32,000 titles for sale, via Audible and via our distribution partner. We now source content from over 334 different providers, 66% of which are multi-year exclusive relationships.

New content relationships forged during the quarter included an exclusive deal with Will Durst, the popular political satirist. We also are planning Ricky Gervais' return in the fall, as well as new and exclusive paid pod cast programs from Bob Geldof. We are also at work in creative ways to engage the user generated media environment emanating from the Web 2.0 movement providing so much [soft] generated media on the web in recent months.

From traditional audio book sector, we have high hopes for new Dean Koontz, Stephen King, James Patterson, Lemonisnicket titles, and also a new book from the LaHaye and Jenkins team behind the Left Behind series.

We also struck a very important new exclusive multi-year partnership in Q2 with the Potter's House, Bishop TD Jakes' world renowned Dallas based church. We officially unveiled a co-branded AudibleListener plan at Bishop Jakes' Megafest in Atlanta just last week, and the response was well inspiring. The Jakes' partnership represents the first time we have designed and even named the membership experience for a specific vertical content and distribution program.

The programming is composed of the minister's sermons and regular inspirational messages, and the delivery system is highly automated and simplified. As the Wall Street Journal reported as we announced this new initiative, "Bishop Jakes will be heavily marketing the program with his [flock]."

The new customers will also find the library of over 1,200 other religious titles when they get to audible.com, many of them specially promoted in partnership with religious publishers such as our friends at [inaudible]. A multi-disciplinary Audible team of designers, engineers and merchants built this new end-to-end Potters House experience, and Audible and Apple work together to sell iPods and memberships at the big Megafest Potters House out in Atlanta.

As a result of the success we've seen at the TD Jakes launch, we are in a great position to take this experience and vertical delivery system we have built and apply it to other vertical opportunities in areas such as comedy, education, and an increasingly high potential area of vertical corporate audio service. The co-branded membership model has lit up a lot of interest from potential partners, who have both customer reach and compelling content.

Audible education continues to prepare for its first back-to-school season, particularly with our focus on the college level during the last half of the year. Our partners running Pearson Higher Education are reporting very strong response from their field reps so far as they unveil our joint plans to rollout the Vango Notes audio download brand this fall. The study guide series focuses on Pearson's Global best college textbooks across 25 disciplines and it will be jointly marketed for professors and students.

Our ability to reach college students during this fall has also been stepped up considerably via a new deal just signed with FaceBook, the popular college social network site, which is actively used by close to 1/2 the students who go to college in the United States every day.

We also continue to focus on how Audible Technology and Techniques can be a powerful force in helping children learn. We're lucky to work with a product that allows us to perceive the social and cultural power of our audio service everyday. We hear of the passionate love of service from adults all the time. If hearing so often now about young people who discover the power of well composed words were listening to Audible context opens up an ocean of new possibilities.

On the Audible Ready Device front, 15 new Audible Ready devices were shipped to stores during Q2. We currently count 217 different compatible Audible Ready digital devices in the market, including new Audible Ready devices shipped in Q2 from Palm, iRiver, Creative, Thompson and RCA.

The quarter included some very expensive development wins on the wireless delivery front. We continue to work closely with wireless operating systems, handset and carrier companies, and we are convinced that our listening service and technology can soar into the mainstream, as new phones come into the market, particularly in 2007 and 2008.

The user experience advance in Fly by Wire alone opens up new market potential, with automated over the air delivery, allowing a customer to get what he or she wants to listen to where ever they are. With Audible Air, a customer has the ability to wake up in the morning with drive time Audible audio already waiting in the [inaudible].

I hope you noticed our announcement of a strong new relationship we recently we recently forged with Sony Ericsson, which includes platform integration and OnBoard Audio resident on their UIQ 3.05, including a Walkman branded phone. We also work with our partners at Motorola on the rollout of the new MotoQ phone, and with Nokia, in making the newest Series 60 phones Audible ready.

Our smart phone coverage now spans four key platforms, UIQ, Series 60, Windows Mobile and Palm. We are making rapid progress towards the completion of full Java support, and will provide access to many more phones.

Analysts foresee there being 500 million Java phones in the market alone in 2010, a potential opportunity we do not intend to miss. The coming era of digital media players that are also phones and phones that are also digital media players help to create the seed bed for significant growth for Audible.

Now I want to take a moment to talk specifically about some of the new leadership talent we brought on board. A very strong leader in marketing, who built the weightwatchers.com franchise, recently joined us, as well as a new Vice President of Merchandising who came to us from Columbia House, where he ran their successful DVD business. We also added a veteran of the publishing community and content acquisition, and a new leader from AT&T Wireless has come on board to manage our customer service support team, a team that is progressively started to touch new and potential customers proactively.

We continue to be intensely focused on all aspects of the customer experience and site speed. The site speed of audible.com continues to improve in Q2, with an average load time improvement of roughly 15% since last quarter. All in, load times have improved by about 22%, and our download throughput is up by about 14% since the site upgrade in February

As a result of this improvement, better communication with our customers and continued improvement in customer support, customer satisfaction levels are up significantly over last quarter. In addition, the average number of calls to our customer service department and the number of help center sessions, each decreased by 35% quarter-over-quarter.

With that, I will turn things over to Andy.

Andy Kaplan

Thanks, Don, and hello, everybody. As Don noted, total revenue in Q2 was $19.1 million, up 25% year-over-year, but down 3% sequentially. Behind this performance was a decline in consumer content revenue at audilbe.com and the iTunes Music store. Contributing factors included a reduction in marketing spending, leading to lower AudibleListener acquisition at audible.com, seasonality and a light quarter on newly published front list titles.

Apple iTunes revenue in Q2 was 22% of total consumer content revenue versus 23% in Q1. During the second quarter of 2006, we added 65,000 new AudibleListener members bringing total AudibleListener membership to 309,000, up by 51% year-over-year, and 11% sequentially.

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 plan, 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, which continues to increase in Q2 by $1.3 million to a total of $9.9 million.

The increase in deferred revenue was due primarily to high AudibleListener membership and a related increase in prepaid audio credits that our customers will be using in the months ahead. The key point here is that much of the unrecognized revenue sitting on the balance sheet today will be recognized over the next three to 12 months as our customers use their credits to download great audio.

Turning to the bottom line, we continue to tightly control costs as we grow. Expenses declined quarter-over-quarter in cost of revenue, marketing, operations and G&A. Throughout the expense, a key component of our cost of revenue declined by 3% quarter-over-quarter in the Q2 to $7.7 million or 41% of consumer content revenue versus $7.9 million or 41.4% of consumer content revenue in the first quarter.

In operations, expenses declined by 8% to 15% of revenue versus 16% of revenue in Q1. Importantly, improvements in the customer experience have resulted in a reduction of customer inquiries for average customers. Coupled with other improvements in our customer support process, the absolute cost of our customer support activities is lower this quarter than in the immediately prior quarter.

In marketing, expenses declined by 17% quarter-over-quarter to 19% of total revenue versus 22% of revenue in Q1. As Don mentioned, this decline was driven primarily by our decision to hold back on marketing spending until the new marketing leadership team was in place. This was also reflected in the cost per new AudibleListener declining by $7 sequentially to $45. This decline in cost per new AudibleListener coupled with the significant decline in Churn, were to key drivers of our reduced loss in Q2 versus Q1.

G&A was also lower this quarter, as expenses declined by 11% quarter-over-quarter to 15% of revenue versus 16% of revenue in Q1. Here we saw lower costs in legal, audit, and recruiting fees.

In technology and development, costs increased by 21% as we incurred some one-time severance and consulting costs associated with transisting the 24 by 7 management of our IT systems infrastructure from an internal function to an outsourced function.

On a non-GAAP basis, which excludes expenses related to stock-based compensation, our operating loss was $1.3 million in Q2, reflecting a $1.3 million improvement from Q106.

Interest income increased to $714,000 in Q2, reflecting earnings on our $60 million in cash and cash equivalents. With that, our net loss for the quarter was $2.2 million or $0.09 per diluted share on a GAAP basis compared to a loss of $3 million and $0.12 per diluted share in the first quarter of 2006.

Audible generated operating and free cash flow in the second quarter of $2 million and $1.7 million respectively. This strength was driven by a continued increase in deferred revenue, representing cash collecting from customers that in the future will flow through to the revenue line on the P&L.

Finally, during the second quarter, we continued our share repurchase program, and repurchased $200,000 shares at an average price of about $9.64 per share.

With that, I will turn it back to Don.

Donald R. Katz

Thanks, Andy. I do want to take a second to reiterate our excitement over the skills, the intelligence, and character and passion we see in the new people joining the cause here at Audible. As most of you know, we are very lucky to have a team that includes people who have been creating Audible for many years, and they bring a level of expertise, stored knowledge, and deep relationships with our hundreds of business partners. It comes back to our customers and other stakeholders as powerful products and significant differentiation versus potential competition.

We continue to talk to candidates for our open CFO slot, but it is wonderful to see new people immediately sharing our collective passion for Audible’s mission.

Let me just wrap up by stating how very excited we are about the future of this business. Our products and services address a tremendous potential market composed of mobile media consumers, and our position as having pioneered the digital audio player. Since then, having Audible readiness standardized within the transformative technologies being embraced by these consumers, iPod, the other MP3 players, PDA, next-generation telephones, EPS devices, even game player -- opens up a huge and mainstream market potential.

We have put important new bedrock in place during the second quarter -- new people, new content distribution and customer acquisition environments, new media platforms, new partnerships, better user experiences, global market developments, and we firmly believe this will all come together to divide our success in the quarters and the years to come.

With that, we will open up for questions.

Question-and-Answer Session

Operator

(Operator Instructions)

Our first question will come from Mark Mahaney with Citigroup.

Mark Mahaney - Citigroup

Two questions -- could you talk a little bit about what new initiatives in marketing you are thinking about for the balance of the year? Secondly, could you talk about consumption patterns you are seeing with the $9.95 and the $14.95 in the higher price plans? Are you seeing an initial ability to transition the $9.95 to a higher price point subscription plan? Thank you.

Donald R. Katz

We are not going to talk a lot about some of the programs we are stepping up, but this new team is ready to roar up, but we really did cool off elements of the paid environments of marketing, and if you just do the math, 20,000 audible listeners were not acquired because of the spending we did not do.

Now, when we come back, we expect that all to come back and then some. We also see really significant step-ups with our channels, which include all kinds of awareness building at the device end, as well as through affiliate partnerships. So we see a bunch of acceleration. We also see some significant content-driven programs going forward, and we also have high hopes for some very aggressive new e-mail programs that we are going to be putting in, which we have been pretty quiet on that front.

Other than that, I do not want to get too specific.

Can you, Dave, take the $14.95 question?

Andrew P. Kaplan

Mark, I am going to talk about AudibleListener Basic, which is our $9.95 plan. I think your question was what trends do we see in terms of upgrading those customers? What I would say is that early on, our goal is to get our basic AudibleListeners into the program and to whet their appetite with promotional offers, or I should say content offers, for new content, in order to incent them to buy more. As we get a better read of their consumption patterns, we will then have an opportunity to ask them if they would like to upgrade from either our gold program, which is a one book a month program, or our platinum program, which is a two book a month program.

You should see more of that over time as we gain experience with these new AudibleListeners and we understand their consumption patterns and we work actively to increase their consumption patterns.

David A. Joseph

Mark, just to expand on Andy’s response, we really have not seen a lot of movement between the plans just yet. We are seeing a little bit, but not a lot. That is primarily because we are waiting for them to get accustomed to the service, get a little bit of a taste for it before we really get aggressive in communicating with them. You are going to see a lot more movement on that front in the second-half of the year. We will see how that goes, but also keep in mind that passport customers who are active are okay with us. They are very profitable and they certainly lend a lot of growth to the top-line as well.

Mark Mahaney - Citigroup

Thank you.

Operator

Next we will hear from Barton Crockett with JPMorgan.

Rob Malathey - JPMorgan Chase & Co.

Good evening, this is Rob [Malathey] for Barton. I just wanted to follow-up briefly on the response to the last question. You mentioned you have not seen much change in up-tick of the different plans. It looks like if you back into an ARPU number, it looks like it was down 20% or 22% sequentially, and I wonder, even if you include deferred revenue, the change in deferred revenue, it still looks like it was down about 15% sequentially. I wonder what is causing that.

Secondly, if you could talk a little bit about the decline in churn, which was obviously very positive, and maybe what you saw that caused that, that would be appreciated.

Andrew P. Kaplan

I am glad you asked both of those questions, because really it is all about the entire equation. It is about ARPU, it is about churn, and it is also about cost per new customer, so let me talk about those one at a time.

First, in terms of the decline in ARPU that we saw this quarter, we actually expected that. And the reason why we expected that is because on the one hand, we have fewer legacy AudibleListeners. Those are the people that when they would pay us $14.95 a month or $21.95 a month, all that revenue hit our P&L each month, because it was the use-it-and-lose-it program. Those customers are either churning away naturally over time or they are converting to our new AudibleListener programs.

So the chief reason why the ARPU went down quarter over quarter is because of that change in mix. I should say that this was an expected change in mix, so we have seen what we expected to see.

Going forward, as our base of AudibleListeners grow and a larger percentage of them are under the new programs, over time you should continue to see that decline, but then the decline should slow down. Once the decline slows down and our merchandising efforts continue to strengthen over time to increase consumption, you will see those ARPUs go back up again.

Rob Malathey - JPMorgan Chase & Co.

Should we expect that same type of sequential decline all through this year?

Andrew P. Kaplan

I suspect you should expect that decline, but probably not as markedly as you have seen in the first quarter of 2006.

David A. Joseph

Just remember that a big driver of that trend are the legacy customers that are coming out and joining our Everest plans, the higher mix of -- sorry, not the Everest but new plan members.

Andrew P. Kaplan

So let me continue and talk about churn. Churn is going down for a couple of reasons. One of the reasons why churn is going down is because our customers like our new AudibleListener programs better than our old AudibleListener programs. They really like the carryover aspects of the programs. In fact, that is one of the key reasons why we changed that aspect of the program, to lower churn.

Another reason why churn is lower, of course, is more people are joining annual programs. Both annual gold, annual platinum, as well as our basic program, which is the $9.95 per year program.

So those are the drivers of churn going down. Let me just add that although we are seeing ARPU go down as expected, with churn going down and customer acquisition costs going down, those two other factors are certainly moving in the right direction.

David A. Joseph

And having a positive impact on the lifetime value versus our legacy customers.

Rob Malathey - JPMorgan Chase & Co.

Just to follow up on the cost per AL in the quarter. Was that artificially low because of the holdback in the marketing, or would we expect that to up-tick back up in the third quarter, or do you expect some consistency in this new lower number?

Donald R. Katz

We are not going to provide any specific guidance on the costs going forward, but clearly we like the trend.

I also just want to add to what these guys were saying. We do expect a really interesting and significant migration upward to the lower-entry point guys once we start programs to build them back up. Also, just don’t forget that we are still seeing really great buying over plan habits by people in the higher plans, which just indicates it has better merchants and more personalized merchants and a significant level of better content where you expect to come in all the time. That also creates a rise in ARPU.

Rob Malathey - JPMorgan Chase & Co.

Thank you.

Operator

(Operator Instructions)

We will now hear from Sameet Sinha with Kaufman Brothers.

Sameet Sinha - Kaufman Brothers, L.P.

Good evening. I was wondering if you could give us some more color in terms of deferred revenue. What sort of revenue recognition trend have you seen? Sometimes might be able to say 20% or 30% gets recognized every quarter. Are you in a position to give that sort of information?

Andrew P. Kaplan

A large percentage of the cash that we receive each quarter flows through deferred revenue into the P&L, and that is because people use most, but they do not use all of their content.

I think that is the biggest statement I can make about the rhythm of deferred revenue.

Sameet Sinha - Kaufman Brothers, L.P.

You would not be able to characterize whether it is 70% or 60%?

Andrew P. Kaplan

No, although I would say that when people join annual programs, if somebody joins an annual planner program for $229, of course that does not flow through the P&L as rapidly as somebody that joins on a monthly basis.

Sameet Sinha - Kaufman Brothers, L.P.

What is the margin on these deferred revenues that you have? Would you say it is 60% if 40% is cost of content?

Andrew P. Kaplan

Well, because we recognize our promotion spending as we spend it, and that is behind us, as dollars that are in deferred revenue at the end of the quarter flow into the revenue line in a subsequent quarter, the only cost against them really is content cost.

David A. Joseph

Sameet, remember it is not 40% cost of content for those particular customers because 40% cost includes the Apple variance in our cost of content, which is a significant number.

Sameet Sinha - Kaufman Brothers, L.P.

Just a question on your technology and development. You mentioned something about increased cost for severance payments because they are outsourcing that function. Could you tell us exactly what you are doing there, and what are some of the critical functions that are being outsourced now?

Andrew P. Kaplan

We used to have a team in-house that would manage the website infrastructure. We decided to move it outside because it could be managed better, and in the long term, it could be managed at lower cost. So for a combination of higher service levels and lower costs, we thought it was the right thing to do.

Sameet Sinha - Kaufman Brothers, L.P.

Thank you very much.

Operator

We will now hear from Darren Aftahi with ThinkEquity.

Darren Aftahi - ThinkEquity Partners

Just a couple of questions, first with the annual membership plans at the low-end, the $9.95, but what kind of uptake are you seeing from members spending on content?

Secondly, I am trying to get a little bit more granularity why you guys are so confident for reaching profitability for the full year?

Third would be with the Sony Ericsson deal, how many carriers are they initially going to rollout with the phones embedded with your product on it?

David A. Joseph

I will take number one, and I guess Andy will take number two and Don will take number three.

In terms of our $9.95’s, we are not going to provide a significant level of detail in terms of the consumption patterns at this point, but what I can tell you is that they are in line with what we were expecting.

Andrew P. Kaplan

The reason why we have confidence that we will be profitable for the full year on a non-GAAP basis is because we have a business plan. We have been managing our progress against that business plan. We have plans for Q3 and Q4, and when you look at it all, it certainly appears to us that we will be profitable for the full year.

Donald R. Katz

Then on the phone, the phones at this point with this developing relationship with Sony Ericsson are pretty much focused on the European market -- very, very cool phones. So the carriers they are working with are in France, Germany, [Orangukay] and others, which in they are working with our European operations there.

Darren Aftahi - ThinkEquity Partners

Thank you.

Operator

We will take a follow-up question from Barton Crockett.

Barton Crockett - JPMorgan Chase & Co.

Thank you. This is actually Barton now. Two questions, one just to be clear -- what are you guys saying you expect for profits on a GAAP, non-GAAP basis for the third quarter? Are you not giving guidance there?

David A. Joseph

The only thing that we are saying is we are pretty much reiterating what we said in the past. We said that we expect profitability to improve throughout the year, and this is all on a non-GAAP basis, so it excludes stock-based compensation, which is always a little more difficult to predict, but on a non-GAAP basis, we expect profitability to improve throughout the rest of the year, and for the full year to be profitable.

I think at this point, everyone is better off keeping their estimates conservative, but what we can tell you is that nothing has changed in terms of our expectations on this end.

Barton Crockett - JPMorgan Chase & Co.

So improved throughout the year, meaning the third quarter would be better than the second?

David A. Joseph

That is correct.

Barton Crockett - JPMorgan Chase & Co.

The stock comp, you guys caught an unusual lump in the first quarter and we thought it might go down in the second quarter, it actually went up a bit. Can you explain what happened there?

David A. Joseph

I think we have been sharing that we have a new compensation plan. We have kind of galvanized the whole company around some very aggressive operating metrics, the top-line, the bottom-line, the net new members, which of course takes in growth and churn, and also the customer satisfaction elements that we have a [inaudible] ranking to.

As part of that, we had a restricted stock investing formula for everyone in the company that goes out several years. That was the [inaudible].

Barton Crockett - JPMorgan Chase & Co.

So would it be at this level for the balance of the year, or is it going to be very volatile, hard to predict, or…?

David A. Joseph

It should not be volatile. It will not go down, but it should not be volatile.

Barton Crockett - JPMorgan Chase & Co.

The final question, just getting away from the numbers here for a second, looking at the Audible Education Initiative, could you give us a sense, in general terms, even if you are not prepared to talk specifics and numbers, what level of impact you expect you might see when we get back into the back to school season and people start looking to download these study guides along with their textbooks?

David A. Joseph

It is too early for us to give any specificity when it comes to the financial impact, but we certainly can offer up the fact that a company with billions of dollars in revenue [inaudible] end up as the biggest player in the textbook market certainly has high hopes for the product. The test data, just seeing the professors and the fields reaction to the Van Gogh notes is certainly strong.

Being able to be with FaceBook as a partner -- I do not know if you know about that site, but FaceBook is used by 7 million to 8 million college students, 60% of whom reprofile themselves every day to a level of intensive granularity, and by having a new relationship with them, we are going to be able to actually test down to very specific levels of granularity once the kind of content that demographic is going to take from us, either educational content or other kinds of entertainment content, so it is pretty exciting.

Then we continue to work with Spark Notes as well, in various college and lower-ed school systems.

Back to school season will definitely show us a lot about those particular markets. As you know, there are many more in education space.

Barton Crockett - JPMorgan Chase & Co.

Thank you.

Operator

We will take a follow-up from Mark Mahaney.

Mark Mahaney - Citigroup

What is the remaining status of the share buyback plan? How many more shares or what dollar authorization remains on the table? Thank you.

David A. Joseph

We have a pretty open authorization from the board, but the basic concept is when we think the stock is deeply undervalued, we are supposed to buy and that is what we will continue to do.

Anything else, Mark?

Mark Mahaney - Citigroup

I’m sorry, you may have already mentioned it, but if you have a specific amount of authorization, is it $25 million or something that is out there that you cannot buy without having to go back to the board for additional authorization?

Andrew P. Kaplan

We have an authorization to buy up to $25 million, but we are required to go back to the board on a regular basis to keep them up to date on our progress.

Mark Mahaney - Citigroup

I am sorry, how much of that $25 million has already been used?

Andrew P. Kaplan

About $2.5 million.

Mark Mahaney - Citigroup

Thank you.

Operator

That is all the time we have for questions. Gentlemen, I will turn the conference back to you for any additional or closing remarks.

Donald R. Katz

I just want to say thanks for joining us. Again, under the covers here, this has been an amazing quarter. Being a more data-driven company is a hugely winning formula going forward. Our financial systems have upgraded massively -- witness the fact we are here today versus a few weeks from now. Things like the customer calls going down, the satisfaction level going up, the site feed going up, having fewer people doing more for more people and the lower cost structure are all very important when you lay that over the fact that we should see the market continuing to open up. A transitional quarter, but we are absolutely excited about everything. Thanks for joining.

Operator

That does conclude today’s conference call. Thank you for your participation.

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Source: Audible Q2 2006 Earnings Conference Call Transcript (ADBL)
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