Audible Q1 2007 Earnings Call Transcript

May. 3.07 | About: Audible, Inc. (ADBL)
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Audible, Inc. (ADBL)

Q1 2007 Earnings Call

May 3, 2007 5:00 pm ET

Executives

Donald R. Katz - Chairman, Chief Executive Officer

William H. Mitchell - Chief Financial Officer

Analysts

Mark Mahaney - Citigroup

Ross MacMillan - Jefferies and Company

Maurice McKenzie - Signal Hill

Mike Olson - Piper Jaffray

Darren Aftahi - ThinkEquity Partners

Scott Kessler - Standard & Poor's Equity Research

Totor Mikev - Sales Fund

Presentation

Operator

Welcome to the Audible Incorporated first quarter 2007 earnings conference call. With us today from Audible are Don Katz, Chairman and CEO, and Bill Mitchell, Chief Financial Officer. Management will first provide a presentation, followed by a question-and-answer period. We will provide instructions for asking questions at that time. 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.

To hear a replay of this and future earnings announcements, you can go to the investor relations section of our website and click to Webcasts and Presentations.

During the course of this conference call, Audible management may discuss some non-GAAP measures in talking about the company’s performance. You can find the reconciliation of those non-GAAP measures in the tables of today’s first quarter 2007 press release.

The statements made in the course of this call which are not historical fact may be deemed to contain forward-looking statements. Actual results may differ materially from those anticipated in any forward-looking statement as a result of certain risks and uncertainties, including without limitation Audible's operating history, history of losses, market for services, and inability to license or produce compelling audio content and other risks and uncertainties detailed in the company’s Securities and Exchange Commission filings.

As a reminder, ladies and gentlemen, this conference is being recorded. I will now turn the conference over to Mr. Katz, Chairman and CEO of Audible. Please go ahead, sir.

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Donald R. Katz

Thanks, Operator, and thanks for joining us today, everybody. I am going to open the call with some highlight and Bill will fill you in on the key financial aspects of a quarter we consider a promising start to 2007, and I will return to briefly update you on various operational items.

The highlights for Q1 include a 28% year over year revenue increase to $25.3 million, which is up 9% over a very strong fourth quarter of 2006. Adjusted EBITDA also rose over last quarter to over $850,000, which was up a bit more than $2.4 million over the first quarter last year. We gained 72,000 new AudibleListener members during the quarter, and ended the quarter with 415,000 net AudibleListener members.

One notable element of the quarter was the shift in new member acquisition patterns. We continued to focus our efforts on higher revenue generating, one-book-per-month members via an introductory price offer, and this resulted in 84% of new additions becoming recurring AudibleListener Gold monthly members, or annual Gold or Platinum members who pay us up front for 12 or 24 audiobook downloads.

The 84% measure compares to 58% of new additions being monthly members in the fourth quarter 2006.

Churn and cost of acquisition are clearly factors worth keeping an eye on as this program shift continues, and while we did see a rise in the overall churn rate to 3% during the first quarter, it is important to note that this rise was almost entirely due to the loss of $9.95 per year basic members acquired early last year who reached the end of their membership and responded to our communications but not re-upping, though we find many continue to purchase items a al carte.

On the other hand, during Q1 the churn rate among month-to-month AudibleListener members actually tracked flat to down, which is promising in light of the significant change in the new customer mix.

It is also promising that our new member acquisition cost fell to an all-time low of $41 per member, down from a SAC of $49 per member last quarter. At this point, defection rates and purchasing behavior indicates the new AudibleListener Gold members coming in at the introductory $7.49 rate can be projected to generate solid multiples of revenue generation and net present value over the basic plan customers paying us $9.95 for annual memberships.

The quarter results are marked by some very solid execution by our merchants, who ran historically fruitful promotions and creative sales communications during the quarter. I will come back in a moment with some operational specifics, but now I want to hand the mic over to Mr. Bill Mitchell to report on the Q1 metrics.

William H. Mitchell

Thanks, Don and good afternoon, everyone. As Don mentioned, total revenue for Q1 was $25.3 million, up over 28% year over year and a healthy 9% sequentially. Our revenue growth was driven by some solid performance from our domestic group where, as Don also noted, we added a much higher proportion of monthly AudibleListener members than we had in prior quarters.

Our U.K. operation had solid post-holiday growth. Sales at Apple’s iTunes site were tremendous. Apple sales represented 31% of total revenue, up from 27% in the fourth quarter.

During the first quarter of 2007, we added over 72,000 new AudibleListener members, bringing total AudibleListener membership to 415,000. This is up 49% over March 2006, and an increase of 8% sequentially. Our focus on adding recurring monthly members rather than the annual $9.95 basic AudibleListener, or value plan members we focused on last year, helped improve the overall mix of our customer base.

Basic AudibleListeners, the smaller and less profitable of the two groups, increased just 8,000 from 142,000 to 152,000, and the percentage of our base they represent declined to 36%.

It’s important to remember that under our monthly and annual AudibleListener plans, customers pay for book credits and access to discounts on sales, as well as get daily subscriptions to either our audio edition of the New York Times or Wall Street Journal. They pay in advance for both annual and monthly plans. This provides our customers the flexibility of using their audio credits on their own schedules.

However, since customers generally can carry over unused audio credits to prospective months, revenue recognition is delayed until the audio credits are used. This unrecognized revenue is included in the deferred revenue account on the liability side of the balance sheet.

Deferred revenue, which can be likened to a sales pipeline, continued to increase by $1.4 million to $15.8 million at March 31st. During this period, we also initiated a number of programs to stimulate the consumption of credits by our customers which helped revenue while also elevating the customer experience. A better customer experience contributes to efforts to control churn which, as Don has pointed out, continues to be headed in the right direction for monthly U.S. subscribers.

We must acknowledge the sales growth at our partner Apple was very impressive during the quarter. This exclusive arrangement to provide audio content at the iTunes sites, which we extended last year through to the final months of 2010, is a fantastic way for our company to diversify its sales and sales models and outlets.

Apple and Audible teams work diligently to continuously identify unqiue content that works effectively for their a la carte oriented customers and customer demographic mix.

It is also worth remembering that we benefit from being on iTunes’ extensive international sales sites, on 22 different international sales outlets and the sales growth there has actually been stronger than it’s been domestically.

Our related revenue for the quarter declined in party due to the timing of payments from our partners. We continue to have great confidence in the growth opportunities in both the German and French joint ventures. While we should not anticipate strong financial growth in this line item or our equity pick-up for these entities during 2007, we think this will be the year we get to the inflection point for profitable, scaled growth in these entities.

Turning to operating expenses, we continue to make progress by focusing our resources on financially productive initiatives. I am increasingly confident that we can start scaling profitably as we continue to grow our revenue.

Total operating expenses for Q1 were up 6.5% to $27.2 million. Non-cash expenses, including stock-based compensation and depreciation and amortization of $2.9 million, were actually down slightly, so our cash increase in expenses was $1.8 million over the fourth quarter.

Over 80% of our increase in expenses came in the cost of content and services, most notably royalty expenses. These costs were $11.6 million in Q1, or 45.6% of total revenue. The increase from nearly 44% last quarter was driven principally by the increase in Apple revenue.

Remember, Apple handles the operational and marketing aspects of their revenue stream and we share a meaningful portion of our iTunes revenue with Apple. This in turn effectively increases the weighted average of our content and services costs percentages. Again, the increase in content services costs associated with Apple sales was the vast majority of the increase in this category.

Expense for operations increased about 20% on a cash basis. This was principally due to some start-up costs associated with the planned migration to a new back-up call center and a slight increase in our staff in Newark.

Our customer care center continues to improve its quality and cost performance, and we are confident elements of the increase will be reduced in the future without sacrificing performance.

Our technology and development costs were slightly higher during the quarter as we transitioned activity from a number of outside consultants to Audible employees in certain areas, causing a temporary expense overlap. I expect that these costs will decline respectively, helping improve our profitability.

Marketing and G&A both had lower operating costs during the first quarter. Rent expense and professional fees declined in G&A. I continue to believe we can gain further economies in these areas prospectively.

In marketing, as Don noted, subscriber acquisition costs or SAC was $41 globally and even lower than that in the U.S. We have become much more efficient with our marketing spend, as we migrate our smart spending to targeted Internet display and search advertising. Additionally, our payments to business partners who help us find subscribers are now made primarily for the one or two book a month customers which generate more revenue but are more challenging to find.

On a non-GAAP basis, our adjusted EBITDA was over $850,000 for the first quarter. Adjusted EBITDA, a term we introduced last quarter on quarter as our principal non-GAAP disclosure, is the classic EBITDA term, which is net income before interest, taxes, depreciation and amortization, to which we add a significant non-cash item -- this quarter, stock-based compensation -- which creates the adjusted qualifier. We believe adjusted EBITDA is the best way to assess the profitability of our business on an operating cash basis.

Our adjusted EBITDA was just over $500,000 last quarter, so we are making progress on building on that success. Our challenge will be sustaining the improvement we continue to see in the first quarter in the seasonally weaker second quarter, but we clearly believe the organization can continue to experience healthy growth in adjusted EBITDA throughout the coming quarters and years.

The loss on equity investment of $60,000 related to our Audible Germany joint venture with our Bertelsmann Holtzbrinck and [Lubet] JV partners. As many of you now, for the first 30 months of this agreement, or through February 2007, Audible earned a monthly fee of $30,000 for the use of intellectual property and technical know-how that we contributed to the entity.

In order to provide additional working capital for Audible Germany, in September we decided to convert the most recent 13 months of this fee into an equity investment in our joint venture. We have also agreed to provide the last five months fees as a capital contribution in an agreement we have recently worked out with our German partners. We continue to be very pleased with the progress of Audible Germany, under the leadership of managing director Eric Meyer, and I encourage you to visit www.audible.de to see all of the creative things our German team is doing.

In Q1, interest income increased to $845,000, reflecting earnings on our average of nearly $66 million in cash and cash equivalents during the quarter. We also have accrued taxes for an ANP liability we estimate having at year-end.

On a side note, we did receive our urban enterprise zone certification in this past quarter, which should generate good savings for us as we finish the build out of our new audio studios here in our Newark, New Jersey facility.

With that, our net loss for the quarter was $1.2 million, or $0.05 per share on a GAAP basis, compared to a loss of less than $1 million and $0.04 a share in the fourth quarter of 2006. The principal reason for the slight increase in the loss was the absence of the $800,000 non-recurring tax credit sale we received in the fourth quarter. That we could only partially offset by our improved operating performance during the quarter.

I want to make sure we point out that we reported just over $4 million in capital expenditures for our Newark facility in the quarter. This will represent the bulk of our CapEx for the year.

Finally, a word about guidance. Audible suspended providing guidance early last year, a practice we are going to continue today. We are still evaluating our short-term pricing and packaging structures for the last half of 2007 and getting a larger sample of the churn associated within the $7.49 offer that we just started late in the fourth quarter of last year. It was actually November 15th.

I have no doubt that eventually we will resume providing guidance during this call but I am not enthusiastic about providing it before we get resolution and data feedback on these two critical areas.

I also note that last year we had a challenging second quarter as consumer Internet usage patterns changed in some regions of the country, making acquisition of new customers more challenging. After looking at our past seven or eight quarters, one can’t help but see some seasonality in our business driven by new consumer device purchases and the holiday buying season.

Now, I will turn it back to Don.

Donald R. Katz

Thanks, Bill. A technical note; I just found out that some of the -- the beginning of our streaming on the Internet was not being picked up apparently, so if you missed part of it, please check the call back and the stored stream, particularly my wham-bang! opening.

William H. Mitchell

Was it that important part?

Donald R. Katz

That was the important part. That’s right. So sorry about that. I think everyone on call-in was fine, but we will pick it up from here. So let’s turn to some specific operational items from the quarter, and let’s start with an update on the content front today.

Audible now makes available 130,000 hours of programming composed of some 37,000 audio titles drawn from 424 different provider partners, including 27 new content deals added in the first quarter of 2007. To supplement the audio that we continuously receive from third party publishers, we have stepped up our original production of audio editions of Harlequin Romances, Vango Notes study guides, a new series of business audiobooks, and a great set of children’s titles.

Because science fiction is so popular with our customers, we added 80 Star Wars titles to our repertoire in February. We recently launched an innovative new weekly science fiction subscription product call Story Pods, composed of short stories by James Patrick Kelly that are automatically delivered each week, and we debuted an original comedy series with the famed Laugh Factory Comedy Club.

To showcase Audible content in front of a wide and qualified audience, we produced three daily programs for our strategic partners at XM Radio in Q1; the Harlequin Romance radio show, and Orson Scott Card’s Universe Sci-Fi show, and a history program called The Ancient World. Each show is broadcast repeatedly throughout the day and promotes the Audible service and related downloadable entertainment.

Beyond the new content additions, including new original erotica as part of a new deal with Virgin Books, compelling new language learning audio programs, a best-selling meditation collection, and new kids audio from Scholastic, our content specialists are consistently working with our vast realm of providers to source special promotional pricing that allows awareness generating pricing and high profile consumer exposure.

A single promotion of 25 titles coordinated with our partners at iTunes during Q1 generated a 22X lift in sales for the included titles between the week before and the week during the promotion. All 25 titles entered our top 50 audiobooks list at the Apple iTunes store and many remained on the list long after the promotion was over.

Similarly, at Audible.com, a single secret sale e-mail that led to a private boutique for members only, and containing 95 specially sourced and promotionally priced audiobooks, created an all-time winner in terms of ROI from a single merchandising effort.

We see this focused and innovative wedding of cooperative work with our content partners and evermore targeted and disciplined merchandising as an important internal driver of revenue per user and increasing margins.

Coming up in Q2, we are looking forward to sales results from new audiobooks by George Tenet, David Baldacci, Russell Simmons, Bishop T.D. Jakes, Joyce Meyer, James Patterson, Dean Koontz and others, but we also note that Q2 has historically not been a time for the quantity of major new releases that drive extraordinary sales or new customer acquisition based on hot new listens.

As you may recall, a Q2 dip in revenue last year was in part traceable to a similar down period for book publishing, book selling, and music downloads, a relatively flat growth environment that persisted well into Q3 for the broader physical media and digital download sector.

I mentioned our focus on kids audio, which is related to our education team’s focus on audio as a next generation means of increasing children’s fluency and enthusiasm for reading. Increasingly, we along with a large number of educators, see listening as an evermore integral aspect of the process of learning to read, and learning to access the substance contained in books.

We find, for instance, that many children, like adults, can and want to listen at a higher level than they can or want to read. For many listeners, comprehension levels can far outstrip comprehension levels from traditional reading.

During the quarter, we continued our testing efforts within classrooms as we worked to develop our kids listening platform with increased original production and the brokering of new deals with the Learning Like Crazy Creators of kids language lessons, an exclusive deal with Barefoot Books, a high quality creator of kids audiobooks, and the deal I mentioned with Scholastic.

Our focus on this category relates to a growth opportunity that is in part created by a profound demographic and behavioral shift that any parent of kids in elementary or secondary school has probably observed. Kids have an increasing affinity with multimedia without a similar increasing affinity for the mastery and love of silent reading. In the minds of parents and educators, this is elevating the potential role of Audible and audio.

On a global plane, where learning to read and write English has become a key catalyst, if not an entry ticket to the emerging international middle class, a general awareness is surfacing that holds that literacy must be a concept that requires fluency in the art of listening and articulating in addition to reading and writing.

So forgive me this momentary diversion from a numbers-driven quarterly call, but we had talked about our efforts with Pearson and our Vango Notes product in the higher ed space in the past, and I thought it important to note that our emerging focus on younger listeners defines an important mid and long-term opportunity for our company, and one of the many reasons we are so optimistic about the future.

Now let’s turn to another operational and strategic sector the fuels our confidence about the future -- the consistent progress we have made with our Audible ready platform. During the first quarter, 24 new Audible ready devices entered the market. As I hope most of you know, Audible ready means that a digital device can access Audible.com outlets here and abroad. An Audible ready digital device also offers a listener the definitive Audible user experience as it also elegantly protects the creator’s intellectual property and revenue.

New this past quarter was the Audible ready Olympus DS30, 40, and 50 line. This is a new generation of digital voice recorders that are fully compatible with the Audible service. As part of our work with SanDisk, the new SanDisk Express, a low-priced audio player, hit the market fully Audible ready. The Express, as of most of our now hundreds of Audible ready devices, arrives with Audible in box marketing material.

We have seen a rapidly rising number of the customers using GPS devices that also play Audible.com content in recent months. In fact, the customer conversion rate for devices like the Garmin Nuvi are quite high. In Q1, the new Zuma, also created by Garmin, was shipped. This is an Audible ready GPS unit designed specifically for, believe it or not, motorcycle riders.

Along with so many others, we are very much looking forward to the unveiling of the Audible ready Apple iPhone, which connects with and plays back our audio content from iTunes as well as Audible.com and our international Audible websites.

We continue to develop the Audible over-the-air automated delivery platform, and last month an Audible team worked with our Nokia partners to demonstrate the Audible air beta application after we were selected to demo the new Audible air app on the high-end N95 line at the CTI telecom conference in Madrid.

Looking into the future a bit, we are excited about our work with XM Satellite and Audible ready devices due out this year, as we are about our work with automotive companies that focus on in-dash integrated Audible ready applications.

Clearly there’s been an increase in the breadth of new devices coming up Audible ready. There is now a broad array of Audible ready iPods and other MP3 players, phones, PDAs, GPS devices, the Audible ready sunglass line from Oakley we reported on a previous call, and in Germany there’s even an Audible ready teddy bear.

Meanwhile, estimates indicate that fully 60% of next year’s new cars will ship with MP3 player connectivity. All of this is clearly good news, but I do want to remind you that this is still very -- there still is a very large disparity between the numbers of digital devices units shipped and the number being used regularly for digital media e-commerce. It is important to note that the trends are entirely indicative that mainstream adoption of the digital media download purchasing habit will definitely occur in the coming years, but there is a stark disparity between shipped player numbers, the subset of that number actually in use, and the subset of that grouping using digital media e-commerce.

Without revealing proprietary data, you simply have to consider the fact that an MP3 player can be and is used to hold music ripped from a personal collection and that only one in 10 digital music downloads were legally paid for last year, and that a tremendous number of new device purchases are replacement purchases made by those habituated multiple iPod and related device owners that so many of us know.

Of course, this will change alongside the growth rates projected for device sales and household penetration, and with the natural demographic changes that by the day turn evermore habitual digital media consumers into commuters and purchasers of information, entertainment and educational materials.

But the point is, as with the still relatively limited consumer awareness of the Audible brand, we are very much at the beginning of the digital media marketplace, not the middle. A large opportunity looms, and you can be assured that Audible intends to be right there and prospering as this large behavioral and economic shift continues.

Before closing up, I also want to mention our U.K. operation. Our U.K. team has demonstrated continued success in growing its content franchise as well as its revenue. There are now 14,200 titles available at Audible U.K. as well as the U.K. iTunes. As I noted in the past, the broad rights we gain from the impressive British content we are sourcing means that we are also in many cases selling these titles in the U.S. and globally.

An interesting example of the valuable synergies reaped from having aggressive smaller start-up Audible.coms as subsidiaries and joint ventures was demonstrated after a successful U.K. ad campaign that included advertising panels placed in London commuter trains and the underground. It is not coincidental that last Sunday, we launched a similar campaign in New York City subway cars that promotes the chance to get smarter, happier, healthier, or richer right here on the subway via Audible.com.

So on the whole, I think we have described a quarter in which intensive focus on core business execution and the road to profitable growth was complemented by strong progress along the additive strategic growth acceleration traits we have identified. We are happy with the change in customer mix and we are focused intently on strong, step-by-step improvements in execution, and on the seizing of incremental opportunities as the digital media marketplace continuously expands.

With that, Bill and I would love to hear your questions.

Question-and-Answer Session

Operator

(Operator Instructions)

The first question comes from Mark Mahaney from Citigroup.

Mark Mahaney - Citigroup

Thanks. A couple of questions, please. First, why no share buy backs in the quarter? Any comments on what you plan to do with buy backs going forward?

William H. Mitchell

We talked about trying to keep our cash balance relatively flat this year. We did spend a lot of money on this quarter in CapEx, so that was counter to our objective on it, so that was our reason for no buy-backs in the quarter.

Mark Mahaney - Citigroup

Okay, and with the mix shift towards the monthly and the annual plans, that should show up in increased ARPU over time. Is that right? It looks like ARPU is just about flattening out now, so is that -- any comments on the trend of ARPU in the quarter? And then is it the correct interpretation that given this mix shift, that we should see that in ARPU starting to grow again at some point later on this year?

William H. Mitchell

That is certainly our thinking as well as we convert those customers that we essentially get $0.89 a month for in revenues. We get $7.49 a month for them at the start and then of course you have to balance their purchases out of plan against the purchases that the new customers buy out of plan, and you have to balance that also against the churn. So there are a couple of moving parts there but we have hoped that we have seen the bottoming out, if you will, of ARPU, and as those $7.49 customers become $14.95 customers next quarter, we will start to see ARPU come back a little more.

Mark Mahaney - Citigroup

One last question, please. I know you are limited in the guidance that you will talk about. You had a quarter where revenue growth acclerated, profitability improved. Given some of your comments about operations costs and technology costs, there may have been some one-time costs related to the move to Newark. It seems reasonable to assume that you could easily have revenue growth acceleration again, especially given an easier comp and therefore EBITDA. The trend we are seeing this last quarter should continue going forward, so is there any particular reason why we wouldn’t see at least EBITDA expansion in the next couple of quarters? Thanks. That’s it.

Donald R. Katz

I am going to talk about the top line and Bill takes the bottom line, but Q2 there is some reason for caution. Part of it is numerically that Q2 competes with very strong lift in Q4 and Q1 that we now realize from having it happen several times that it is created by seasonal consumer purchasing and a combination of that with seasonal high profile content releases in our category, and then there is new device activation trends, which are very strong in the beginning of Q1.

Meanwhile, history shows that Q2 web traffic flattens across the sector, we get fewer hot titles from the providers because of the publishing cycles, and digital media downloads flattens across video and music, was just a characteristic last year that continued through Q2.

I hear what you are saying and I will let Bill talk about the EBITDA implications, but I think this is a case where we are not giving guidance but we want to offer up a sense of caution.

William H. Mitchell

At the operating level and once you get beyond revenues and royalties, I think there is probably still some opportunity for improvement in the operations area on the expense side, relative to revenue, as we move forward. You saw some nice movement in that area in both marketing and G&A during the quarter and I would like to think that now that we are through the move here and we have made some strategic transitions to internal employees and a new call center, we are going to be able to improve those other two areas on the P&L from an expense side going forward.

The wildcard remains revenue and then we’ve got to manage the merchandising correctly on the content services side.

Operator

Your next question comes from Ross MacMillan from Jefferies.

Ross MacMillan - Jefferies and Company

Thank you. Bill, can you quantify what the one-time costs were in the quarter?

William H. Mitchell

We are not going to get into it specifically but we had some substantial costs in just transitioning a call center. We kind of had an overlap of two call centers for one month and we had an overlap of 10 employees or so for one month in the P&D area, and shifts in the processing side.

It is not like it is $0.5 million, Ross, but it is not a small number either.

Ross MacMillan - Jefferies and Company

Okay, that’s great, and then just on the cash flow, you’ve got this negative impact from the accrued royalty, can you just remind us what that is in terms of the timing impact and how that will play out as we go through this year?

William H. Mitchell

You say negative impact from the accrued royalty -- are you talking about -- is the accrued royalty or the deferred revenue side?

Ross MacMillan - Jefferies and Company

No, the accrued royalty, which was negative $1.7 million on the cash flow versus basically --

William H. Mitchell

Okay. So that is the amortization of some prepayments and that should smooth itself out as we move forward here.

Ross MacMillan - Jefferies and Company

Okay, so that will be flattening through the year?

William H. Mitchell

Exactly.

Ross MacMillan - Jefferies and Company

And the, I just missed one thing, I just want to clarify two points; one is you mentioned something between 142,000 and 152,000, part of your member base. Could you just go over that point again?

William H. Mitchell

That is the Basic AudibleListener plan/value plan customers that pay us $9.95 to become a member in the AudibleListener program, where they get access to 30% discounts over the course of a year, and so we recognize $0.89 a month of revenue from that $9.95 while they are members for a year, and then they get 30% discounts when they buy books in our store.

Ross MacMillan - Jefferies and Company

And that was an increase of 142 to 152, or --

William H. Mitchell

That’s correct. It was an increase but as Don pointed out, it was a much more modest percentage increase than we had experienced in prior quarters. You started to see that trend shift in the fourth quarter where I believe it declined to 56%, and then this quarter it was down to -- was it 15%? Yes, 16% this quarter.

Ross MacMillan - Jefferies and Company

I guess the key question is as you transition more people to the monthly plans, let’s say with the introductory pricing, and then you have to up those guys onto the full monthly pricing, have you got any sense for how that will be impacted, or that will impact churn, or is that just a big unknown right now?

William H. Mitchell

Well, it’s not a big unknown. We started the program in December. It is a three month period of $7.49 discount before they move to $14.95, so you can do the math. We have two months under our belt, if you will, of experience in people moving into the $14.95 price point and we are seeing some churn.

We just want to be a little farther along. We can certainly get into it a lot more in our second quarter call when we know more than we know now about how that impacts churn.

Ross MacMillan - Jefferies and Company

One very last housekeeping on Apple, 31%, was that of total revenue or content revenue?

William H. Mitchell

That was of total revenue.

Ross MacMillan - Jefferies and Company

Great. Thanks so much.

Operator

Your next question comes from Maurice McKenzie from Signal Hill.

Maurice McKenzie - Signal Hill

Congratulations, guys, on the quarter. Just a couple of questions, the first is on advertising and promotions. Can you discuss the performance of various elements of your marketing mix in the quarter? How effective was your pay-per-click campaign, and are there web channels that are more or less effective in converting browsers to customers and subscribers?

Donald R. Katz

We can tell by the new customer additions going up and the SAC going down, that clearly there was a level of efficiency that was pretty strong. We have shifted more strongly, as Bill said in his comments, to the web and it seems to be that the population of people on the web would have devices. Our history going back a while is that SAC was much higher because we were pretty dependent on getting people devices, getting devices into their hands, and clearly the device universe has expanded, so we can target more effectively and assume people have devices in many cases. That helps.

Plus I think last quarter we reported a very significant upgrade in the science of our search-based campaigns, which became much more efficient and a higher percentage of our growth. And we have been optimizing our affiliate channel too. So there has been definitely some positive trends, so we were pretty pleased with the way it went.

Maurice McKenzie - Signal Hill

Second question is really on smartphones. In terms of conversion, can you talk about that in the quarter? I know it is a little early. Also, are you seeing any behavioral difference between smartphone owners and owners of traditional MP3 players?

Donald R. Katz

That’s a really good question. We definitely see with people using Audible Air more usage of the subscription products because that makes sense. You wake up in the morning and you have a Wall Street Journal or a New York Times or the new New Yorker kind of waiting in your phone. It has a lot of utility, as does the fact that you can download from our library anywhere with your phone.

But at this point, we are -- it really is not rolled out massively simply because the device universe is still developmental and we are getting better at it, but it still is a beta program and we expect to turn it into money in the coming months and years in a big way.

Operator

Your next question comes from Mike Olson from Piper Jaffray.

Mike Olson - Piper Jaffray

Just a quick question about the guidance again, and not to go after you on this, but as far as sub adds, it sounds like you are suggesting sub adds should be down quarter over quarter, which is kind of what I think ourselves and others were looking for. For revenue though, should we just kind of assume, as was the case last year, that in general Q2 is going forward with some seasonality, that revenue should be down quarter over quarter?

William H. Mitchell

Great try, Mike, but we are really not giving guidance. You might look at some of the trends in the past, which I know are going to be complicated by the mix that we had last year. I think that will be the best thing to tell you about it. If you look at what happened in the second quarter last year, we were adding a lot of those value customers, so they really impacted the mix and they really impacted ARPU.

So think about that when you try to go forward with your projections, but we have really tried to level out the impact of value customers on ARPU.

Mike Olson - Piper Jaffray

Okay, and then anything new on the competitive front, as far as any new competitors that you guys are hitting up against more now than in the past couple of quarters?

Donald R. Katz

No, not really. There is a company called Overdrive that is doing well in the library space, doing downloads using a Microsoft platform. But we have not really heard a lot that is worth noting.

Mike Olson - Piper Jaffray

Lastly, as far as new geographies, is there any plan for any other new geographies that you are looking at branching into?

Donald R. Katz

The only thing -- I think I mentioned just in passing is that we do have an office now in Tokyo and we are seeing more deals coming through the reporting system that our lead there is starting with really good Japanese publishers. iTunes is our distribution method over there. We don’t have an Audible.com but we are certainly seeing or able to see a pretty global demand structure because there are so many iTunes that are to some extent, at the very least just stocked with English content from Audible in over 22 different countries now, so it is a pretty good way to see where the opportunities are such as we saw in the U.K. in a big way that it was time to step that up.

The U.K. is really doing quite well. It is worth noting when you look at the P&L, you see just the Audible.com U.K. revenue, but when you add in the iTunes revenue, it is a really significant and significantly profitable operation very quickly, which was I think not expected by people watching the company when we decided to do it.

William H. Mitchell

Just piling on a touch, you get a lot of administrative benefit by allowing Apple to carry the water for you into lots of other countries where they’ve got a much larger presence and understand how to do business more effectively and appropriately in those countries. I think for the time being, it is a really nice approach for a company our size to have.

Mike Olson - Piper Jaffray

Thanks.

Operator

Your next question comes from Darren Aftahi from ThinkEquity.

Darren Aftahi - ThinkEquity Partners

Just a few quick questions; your deal with iTunes and Apple, since the iPhone is exclusive with Cingular, does that impact you from doing any other deals with other carriers?

My second question, what directionally can we assume in terms of CapEx for ’07 for the full year, relative to ’06? And then I have one follow-up question on housekeeping.

Donald R. Katz

I’ll take the first one. No, however the iPhone gets into the market, it accesses our content in two really important and proven ways, so we are not very aware of it having anything to do with -- as much as it sells, we’ll get the business. In terms of any other carrier deals or other devices or anything like it, absolutely not. There is no relationship.

William H. Mitchell

On the CapEx, we did say I think in the last call we anticipated an expenditure of about $5 million to move into the Newark facility, and then there would be base business implications for expenditures for the rest of the year. So if you look back at our history and you will see that’s in the $1 million to $2 million a year area for CapEx.

Darren Aftahi - ThinkEquity Partners

My last question, you said I think in the press release for this quarter, it says your EBITDA was $541,000 in the fourth quarter of ’06, but if I look back in the press release you put out for the fourth quarter, it says $800,000 on adjusted EBITDA. I’m just trying to reconcile for the difference.

William H. Mitchell

Nice diligence on that, Darren. We, as I think we announced after the phone call, we had identified a problem with value-added tax in our international sales at Audible.com and due to the immateriality of that, which was about $200,000 annually, we recorded that in the fourth quarter of last year because we had reported all the other numbers.

Darren Aftahi - ThinkEquity Partners

Okay. Fair enough, thanks.

Operator

Your next question comes from Scott Kessler, Standard & Poor's Equity.

Scott Kessler - Standard & Poor's Equity Research

Thanks a lot. There has been a lot of talk about the increasing relevance of Apple to your company and to your company’s business. I am wondering if you can possibly highlight what you guys think the major implications of Apple and its growing importance to Audible on the rest of the P&L? For example, I think that is probably a good way to leverage marketing efforts. On the other hand, maybe it negatively impacts gross margin.

The second question I have involves the guidance. There has obviously been some talk about this and I guess I am trying to get a sense as to when exactly do you expect to provide guidance again, because correct me if I’m wrong but I think it’s been -- has it been a year at this point that we haven’t received guidance?

I understand that you have no new programs that you are gathering data on, but I guess I’m just trying to figure out when we should expect to get guidance at this point. Thanks.

Donald R. Katz

I’ll take the Apple question first. Obviously the character of the revenue stream from iTunes affects gross margins, but then the character of that revenue stream as it comes to the bottom line is different because they are marketing, they are creating the traffic and they are doing a lot of the operational work, so it is a much different revenue stream in the way it comes down. So that’s important to note.

And then clearly, another part of it is that we have a tremendous number of Audible.com customers who use iPods. That has no particular financial ramifications beyond the fact that they are able to use iPods, which just expands our market universe, since iPods are such a profound part of the digital media universe. So that’s all a positive.

We mentioned the global aspects of the relationship. Given our realignment and the deal we did that extended our deal that goes back to 2002 and 2003, and changed it to be a much longer term deal, and as we have detailed in the past, a much more aligned deal economically, and just the character of the day-to-day work we do with Apple, it is hard to find any negatives in there at all.

William H. Mitchell

On the guidance side, of course, I’ve been here five months. I’m not sure exactly when the company stopped giving guidance, but we have made two significant changes in the past quarter and we have a third that we are actually going to be getting into this particular quarter. I think we would like to -- the one this quarter where we are actually going to start doing more of our own audio production internally for some of the books, the educational books in our educational initiative with both kids and colleges, and stepping up that volume has some implications initially that I think are going to work out very well for us. We just want to start getting through it and see where it’s going to come online.

So those two elements, particularly the new pricing changes that went into place at the end of the year last year, I think we would like to see how the churn on that works out and, as I think I mentioned, we will be a lot closer to defining when we would be able to give guidance on our next call as opposed to right now.

Scott Kessler - Standard & Poor's Equity Research

Don, if I could follow up, are you concerned at all about what seems to be a correlation between the increasing percentage of Apple generated revenues and the deceleration in growth in AudibleListener adds?

Donald R. Katz

Decelerating AudibleListener adds -- well, I think I saw them accelerating over Q4, despite putting a higher hurtle of a higher price tag in the membership, so I’m not so sure I understand that statement.

But if you are looking at their growth rate versus our growth rate, no, actually. They have a profound a la carte environment. We are seeing, now that we are segmenting and being much more differentiated in how we are merchandising there, a different kind of user base that is actually attracted to different elements of our gigantic repertoire. It is not the recurrent habituated membership model and it is actually very complementary. It stands to reason, given what is going on with iPods and the fact that you go to iTunes when you get an iPod, that they should be growing more quickly.

But as this point, to the character of the deal and the depth of the relationship makes us feel really confident that we -- we have actually complementary business models that are working very well.

So no, it is really not an element of concern.

Operator

Your next question comes from [Totor Mikev] from [Sales Fund]. Please go ahead.

Totor Mikev - Sales Fund

I could be looking at the billings growth, and the way I define billings is revenues plus sequential change in deferred revenues, and it looks like in the past couple of quarters, it has been trailing the year-over-year growth in revenues by about 6%. I’m trying to figure out what the cause for this is. Is this due to the subscriber mix change or is there something else going on?

William H. Mitchell

So you are taking revenues plus the change in deferred to get cash sales and you are noticing that -- I think we did see that our increase in the deferred was down this quarter versus prior quarters, and you are saying that -- what is the exact relationship you are experiencing?

Totor Mikev - Sales Fund

Well, I’m saying that your revenue has been growing 28% in the past couple of quarters, year over year, and the billings have been growing 22%. This is unusual for your company because typically you are growing billings faster than revenues. So I am trying to figure out -- obviously something changed.

William H. Mitchell

Well, the one thing that we did see some more of this quarter than last quarter is that we did see some credit consumption increase, and that will have an impact of that.

The other thing that eventually should have happened is that because you are looking at a higher number, the same growth patterns should create a lower percentage. I think those are the two elements that are causing you to have a lower growth, but I would be happy to have you call me offline and we can go through the exact math on it and make sure we reach the same conclusion, which I believe is A, you are working off a higher number, and B, there is a little bit more credit consumption going on this quarter rather than last quarter.

Totor Mikev - Sales Fund

I understand. Thank you.

Operator

Your next question comes from Scott Kessler from Standard & Poor's Equity.

Scott Kessler - Standard & Poor's Equity Research

Two quick things; I just wanted to follow up, Don. I think the discrepancy between what I was looking at in terms of AudibleListener add growth is quarterly versus yearly. I’m looking at yearly because I think the seasonality is better focused or framed there.

Donald R. Katz

Yes, but don’t forget the mix was entirely different a year ago. We were offering people memberships for $9.95 for a year, or as Bill put it, $0.82 a month for the privilege of the discount buying versus asking people to commit to a month-over-month book-a-month.

William H. Mitchell

Yes, take a look at the SAC that was being spent last year also.

Scott Kessler - Standard & Poor's Equity Research

Right, no, I think that that’s very relevant. The other question I had is do you plan on breaking out specifics related to how you fare in Q3 relative to the education offering? I guess some of us are awaiting indications that that will materially contribute to the company’s financials this year, so anything in terms of revenues or profitability or anything like that would be helpful.

Donald R. Katz

I’m not going to promise it, but obviously we are excited about it. I can tell you that the Vango Notes part of it as opposed to the kids part of it, which we are ramping up very quickly, as Bill and I both mentioned. For the spring semester, we expect to have 260 guides ready for the market -- actually, 210 for the fall and then 260 for the spring. As we get deeper penetration of the text market with products, obviously our opportunity grows massively.

Similarly -- first of all, this is really a strong product. I would encourage anybody to just go into the Vango Notes collection and just try to click on any of them. They are surprisingly fascinating and well-produced, but we also have a physical sales force learning and trying to sell this and the sales cycle has some time on it. We are seeing new programs, such as the stickering of the textbooks with the promotions for the Vango notes, downloads and other things from the Pearson sales force, as well as our own online efforts, including having the stuff available on iTunes and other efforts that we are excited about.

It is probably -- we will be as visible as we can be about it, but at this point it is a product development and sales effort that we are excited about but not probably material enough to break out.

Scott Kessler - Standard & Poor's Equity Research

Okay, that’s great. Thanks a lot.

William H. Mitchell

I think that will wrap it up for today. Don, do you have any final words?

Donald R. Katz

No, I just look forward to keeping everybody abreast of our progress and we remain really excited about what’s going on here.

William H. Mitchell

Thanks for following us and thanks for joining us on this call. We will talk to you in three more months.

Operator

Ladies and gentlemen, this concludes the conference call for today. Thank you for your participation. Disconnect your line and have a great day.

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